Wait, you didn’t buy some Burnt Hair cologne? Well, don’t worry, because enough people did (at $100 per bottle) that they sold 20,000 bottles already (well, according to Musk) which means that The Boring Company can add another $2,000,000 to their accounts. Now, we’ve covered Musk before but he continues to add to his collection of companies. According to Wikipedia, he now is

• Founder, CEO, and Chief Engineer of SpaceX

• Angel investor, CEO, and product architech of Tesla

• Founder of The Boring Company

• Co-founder of Neuralink

• Co-founder of OpenAI

• And soon to be owner of Twitter

While he is a busy man, this opens another topic — Mimetics.

What are Mimetics?

In mimetic theory, mimesis refers to human desire, which Girard thought was not linear but the product of a mimetic process in which people imitate models who endow objects with value. Girard called this phenomenon "mimetic desire", and described mimetic desire as the foundation of his theory:

"Man is the creature who does not know what to desire, and he turns to others in order to make up his mind. We desire what others desire because we imitate their desires." (wikipedia)

In other words, what we desire is not what WE desire, but what other “influencers” have TAUGHT us to desire.1 This creates a weird dynamic where it is easy to be manipulated by what other people tell us what is going to make us happy. It is not clear that it does make us happy. Instead, it may only produce the illusion of happiness for a relatively short time.

Torches of Freedom

In 1929, Eddie Bernays conducted one of the first public relations projects in changing how society perceived women smokers. Before that, women who smoked were thought to be of low character.

In the nineteenth century it was thought that only fallen women, ‘whores’ and ‘prostitutes’, would smoke. Only sly, devious and ‘characterless’ women were shown to be smoking on screen. The next was to teach women how to smoke properly. Apparently the few ‘respectable’ women who did it publicly made a mess of it and Hill was anxious that such clumsy displays would put fashionable women off this pursuit.

So how do we change that perception?

On 31st March 1929, at the height of Easter Parade, a young woman named Bertha Hunt stepped out into the crowded fifth avenue and created a scandal by lightning a Lucky Strike cigarette. The incident was highlighted even more because the press had been informed in advance of Hunt’s course of actions, and had been provided with appropriate leaflets and pamphlets.

Okay, let’s review some key components of this situation. First, Bertha Hunt was not a random woman. Instead, she was Bernays’s secretary. The cigarette was a Lucky Strike, the company that hired Bernays to create the campaign. The press was ready for it because they had been provided lots of information already about the situation. None of this was “random”.

Ten young women followed Bertha Hunt that day down Fifth Avenue, brandishing their torches of freedom. The audience’s imagination was captured as newspapers enthusiastically reported on this new scandalous trend.

The NY Times published an article on April 1st, 1929 titled “Group of Girls Puff at Cigarettes as a Gesture of 'Freedom’” to drive home the point. Remember that the press was geared up for this situation due to the information that they received about the events that were pre-planned.

Overall, Bernays created an environment that showed women smoking in a strategically structured setting (the Easter Parade, press coverage, women selected to create the right appearance, etc.) that changed the way society perceived of women smoking.

A More Recent Example — Birkenstock Boston Clogs

This Monday on the drive to Rogersville, MO to see our daughter my wife was talking about Birkenstock Boston Clogs. It appears that TikTok has created a sensation in Clay Boston Clogs that have been around for over 40 years and they are now an “it” shoe. Instead of selling for their list price, they are selling for twice that. Why? Because TikTok influencers declared them as one of the shoes to own for this year.

It is not that the shoes have changed. Instead it is due to influencers telling us what we desire to have has changed.

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Why Does This Matter?

The reason it is important is that public relations campaigns have gotten a lot better since 1929. At the time, that was a relatively new arena (although it had been in practice for a long time before becoming formalized). Eddie Bernays referred to public relations as

an "applied social science" that uses insights from psychology, sociology, and other disciplines to scientifically manage and manipulate the thinking and behavior of an irrational and "herdlike" public.

Think about that for a minute — “to scientifically manage and manipulate the thinking and behavior of an irrational and "herdlike" public.”

Robert Cialdini, PhD is the author of the book “Influence: The Psychology of Persuasion”. This excellent book looks at reliable techniques to manipulate the actions of people. Want to move a product? Make it look like there is a limited supply. Ever notice how long the McRib has been sold at McDonald’s “for a limited time”? It works. There are many more “tips” to use or be on the lookout for how people are trying to influence your behavior.

What has changed? One key item is social media. I’m writing this on Substack and sending my voice out to whoever wants to read it. Okay, I only reach a touch over 400 subscribers. On the other hand, Elon Musk, Donald Trump, Kylie Jenner, Dwayne Johnson, Charli D’Amelio, Barack Obama, and many others can easily reach out to 50+ million people on a regular basis (many reach out to over 100 million people). This kind of reach is incredibly powerful. It also doesn’t matter whether the impression is good or bad…just that the message is getting out there and into the zietgeist. It is getting circulated. Whether Barack Obama or Donald Trump are getting people to agree with them or disagree with them may be relevant, but probably less relevant than that they are constantly taking up space in our minds.

Donald Trump and Barack Obama manage to both rouse their fans and opponents. Elon Musk posts about Burnt Hair cologne and it sells out (in the day or two I’ve been writing this, he officially sold all 30,000 bottles for a cool $3,000,000 in revenue). While this is a rounding error to his net worth, it is brilliant marketing.

Think about LeBron James, Patrick Mahomes, Serena Williams, and countless other sports performers not only make millions of dollars playing their sport, but also more by selling products. Remember the crypto ads of LeBron and Matt Damon?

Why did they get the advertisement role instead of someone who knows more about cryptocurrencies? The reason is that people are more likely to respond to Matt and LeBron, rather than someone who can fully the advantages/disadvantages of Bitcoin, Ethereum, blockchain, etc. LeBron and Matt are selling the potential of getting wealthy from cryptocurrencies, rather than the risk-return tradeoff and how it would fit into a portfolio. They are selling the desire to get rich and famous, because they already ARE rich and famous. It had nothing to do with their skill and ability in the cryptocurrency arena, but their skill set in basketball and acting.

Another big advantage is that people are more aware of how to work the crowd today rather than just present information. Presenting information allows the consumer to weigh the advantages and disadvantages of the service, product, etc that is being sold. Influencers are instead using their personalities to sell the desire for consumers to own the product. It’s a subtle, but powerful difference. The first is likely to lead to more optimal consumer decisions (intrinsic motivation), rather than people who are temporarily happy (extrinsic motivation).

Try to avoid falling for mimetic desire and instead focus on making decisions that are going to make YOU happy. Think about what you value (not what you think others are going to value) and pursue those things in life. You’ll be happier.

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Okay, I didn’t really get “pulled” back in, but decided my sabbatical had run it’s course so more of a case of jumping back in. However, I like the quote, so…

I’ll probably be a bit more sporadic this time around, so be warned that your schedule will be less predictable. No more regular 2:00 AM (CST) updates on Wednesday morning, but instead they’ll get out when they get out.

Three Free Liberty’s Highlights One-Month Trials

Again, you know you want to read Liberty’s Highlights and the cost is FREE! There are three free one-month trials out there for you to claim (donated by LibertyRPF himself — Thank You!!). Even if you’ve already won, enter again by sending me an email or reply to this forum. The FIRST THREE responses will win. You’re not under an obligation to subscribe, but I think after you see 12 episodes, you’ll want to expand that to a full year and join me and others as paid fans.

Range Widely

I’m sure I’ve mentioned David Epstein’s Range Widely column before, but he had a recent column that is worth another look. Here is his column on running and why it is good for you regardless of gender. One of my favorite takes from this column is this one

WOW! I don’t necessarily want to live longer (well, actually I do as long as I’m still mostly functional), but I want my (reasonably) healthy years to be as long as possible. This is a great argument for staying fit. Side note is that it doesn’t matter if you run, lift weights, walk, crossfit, backpack or whatever keeps you active. The better your VO2max is, the more likely you are to have more functional years in there. Obviously, randomness is going to play a big part…and there’s not much we can do to manipulate that lever. However, working to stay fit is likely going to be a major factor on our ability to stay functional as we age and I’m all for that.

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A Return To Higher Education

A recent tweet caught my attention as it looks at one of the challenges facing higher education — how do we make it more functional for those involved? You can find the story here (and note that you are receiving a piece of the story…not the full picture because each person is going to experience it a bit differently).

Essentially, it is a question about whether the class itself is too hard or the students are not putting in the appropriate amount of effort…or, most likely, a little bit of both.

Let’s introduce the story a bit and then delve deeper into the details. Dr. Maitland Jones, Jr. teaches a section of organic chemistry at NYU. Depending on who you talk to, he was either one of the coolest

He received awards for his teaching, as well as recognition as one of N.Y.U.’s coolest professors.

or most dismissive faculty members on campus.

But Mr. Beckman defended the decision, saying that Dr. Jones had been the target of multiple student complaints about his “dismissiveness, unresponsiveness, condescension and opacity about grading.”

Dr. Jones’s course evaluations, he added, “were by far the worst, not only among members of the chemistry department, but among all the university’s undergraduate science courses.

The truth is that he was probably both. Side note — I’ve had students tell me that I was their favorite professor on campus AND students tell me that I was their least favorite professor on campus.1 Teach a broad enough sample of students and you will hit both extremes.

Who is Your Customer — The Student or Society?

One of the challenges of teaching is trying to figure out who your “customer” is. For many industries, this is relatively easy. Unfortunately, this is not true for higher education. You actually have multiple possible answers.

There is the student who is actually taking the class. They are the one deciding what to major in, which instructor to take, whether to take the class online or in-person, etc. The challenge is trying to figure out what they want from the course. Is it an easy A (or a passing grade)?2 A class where they memorize the material? A class where they learn to understand the material and how to apply it? There is definitely an argument that they are your customer, but if so, what strategy do you offer to make the customer happy?

There is also the parent(s) who may (or may not) be helping to finance the student’s education and wants their kid to be successful. While there is a lot of variance, parents are probably less concerned about the “party” atmosphere of campus. They are going to want career paths that are going to be rewarding for their kids (both financially and personally). When it comes to an art class or a STEM class, parents (again, on average) are going to want their kids to choose STEM-oriented careers.3 Specifically, this Forbes article argues that "A majority (65%) of respondents today work in the field their parents wanted for them." That’s a pretty strong number!

Another potential customer would be the businesses that hire the students. They are going to want students who understand the concepts and how to apply them. They are also going to want grades. Given the choice of hiring a student with a GPA of 2.5 or a student with a GPA of 3.8, most businesses are going to go for the student with the 3.8 GPA. The GPA is a “signal” of how well the student is doing at processing information, completing assignments, balancing multiple deadlines across classes, working in teams, etc. These are proxies for the skill sets that employers are looking for from their new hires.

Going back to the student that wanted the easy A, you can start to see the problem. Getting a B in a class and learning the material is less beneficial to the student than getting an A in the class. It is going to impact scholarships, interview opportunities, and allow more time to pursue current job opportunities and/or extracurricular activities that will help them get their career path started in the right direction. As Charlie Munger says

Another potential customer is university oversight. These refer to the many different regulatory organizations that provide a review of the university's performance. Three examples off the top of my head (for our school) include the Kansas Board of Regents, Higher Learning Commission, and AACSB (there are many more). The purpose of these institutions is to ensure that learning is occuring within appropriate guidelines.4 However, there is an issue with answering to too many bosses that can wear down teachers. You spend more time doing paper work (or filling out online forms) and attending meetings which distracts from the time you have to develop classes and interact with your students.

There are benefits to rubrics in that they tell students how the project is going to be graded.5 This is great as they know what is expected and help keep professors honest in their grading.6 However, if they start doing the project BASED on the rubric, they are maximizing their grade and quite often are no longer focusing on what they should be LEARNING from the project. Focusing on oversight of education is likely to create as many problems as it fixes. However, there is a big difference between faculty teaching because they have a passion for doing it vs. faculty teaching because they are obligated to so.

So, who is your customer? They each have different objectives and optimizing for any one of them is not going to be optimal for the others.

The best instructors try to envision where the student is going to be after they graduate and create lectures to help them get there.7 This is true across campus, regardless of whether they were teaching finance, business law, photography, nursing, or mathematics. Teaching how to think is much harder to grade (for one, it assumes instructors know how to think which was always up for debate in my classes). You are grading the thought process rather than the ability to spit out a formula and apply the formula correctly. Ideally, you are doing both -- grading the ability to apply the formula WITH the ability to understand and apply what you just calculated.

If I ask you to estimate the future value of $1000 PER YEAR saved for 40 years at 12%, are you going to give me a number of less than $40,000 (this occured every year in Investments II), a number between $40,000 and $100,000, a number between $100,000 and $1,000,000 or a number greater than $1,000,000? Note that if you do the calculation, you will get an answer of $767,091. When asked to provide an estimated range, that would give them a 75% chance of getting the correct answer within that range, the results were often discouraging.8 In 2019, I had about 9% of students get the range right (note that someone who said between $100,000 and $1,000,000 would be right whereas someone who said between $200,000 - $400,000 would be wrong). The number of "correct" responses would vary from year to year, but never exceeded 25% (and often was far less than that).

Granted, we expect the “confidence” in our answers to be too high, but it always amazed me the number of guesses that were not close. There were multiple reasons for this (end of semester, students not wanting to spend time thinking, people who guessed $500,000 - $700,000, etc.), but the reality is that students who had spent the last year doing literally hundreds of time value of money problems, struggled to get the right answer (fortunately, they did these problems across other classes, so I was only partially to blame and it was the expected outcome). Still…

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Back to the Story

Let’s get back to the story itself where NYU terminated the class of an adjunct professor due to student performance. It is open to debate whether the class was too hard or the student’s too soft (I’m going with it was a bit of both). The initial solution was

The officials also had tried to placate the students by offering to review their grades and allowing them to withdraw from the class retroactively.

It wasn’t exactly the passing grade that they needed, but it also wasn’t going to damage their GPA. As the school described Marc A. Walters, director of undergraduate studies in the chemistry department as saying

the plan would “extend a gentle but firm hand to the students and those who pay the tuition bills,” an apparent reference to parents.

As the article states,

Should universities ease pressure on students, many of whom are still coping with the pandemic’s effects on their mental health and schooling? How should universities respond to the increasing number of complaints by students against professors? Do students have too much power over contract faculty members, who do not have the protections of tenure?

This goes back to the question of who are you teaching to? The students and parents (at least of those doing poorly in the class, which is not all students) are going to be happier with this solution.

Dr. Jones responded with the following

The problem was exacerbated by the pandemic, he said. “In the last two years, they fell off a cliff,” he wrote. “We now see single digit scores and even zeros.”

After several years of Covid learning loss, the students not only didn’t study, they didn’t seem to know how to study, Dr. Jones said.

I can say that this was one of the issues that I saw in my classes as well. I’m not sure if it is more of an issue in degrees that have specific requirements — I need to complete requirement X with a grade of B or higher to move on to requirement Y — or not. However, my gut feel is that this IS part of the issue. These students are outcome-oriented learners. Rather than learning because they are interested in organic chemistry (or finance), they are interested in meeting the outcomes rather than learning the material (and again — this is not all students). I often speak of a range of students that used to be about 25% that really wanted to learn, 50% that would vary from day-to-day, and 25% that didn’t really care. However, since COVID and increased online education, I would say that the numbers dropped to about 15% that really wanted to learn, 35-50% that would vary from day-to-day and anywhere from 35-50% that didn’t really care as long as they got the grade that they wanted.

There is also a question of access to professors. If you are on campus, it is easy enough to stop by the professors office and ask for help. However, what if you are trying to learn from home? You may be studying at night and have a question. You email the professor who doesn’t see it until the next morning, has a meeting/class and get’s back to you in the afternoon. You don’t see the response until the evening. Instead of spending 5-10 minutes talking through the issue, you spent a day (or more) trying to get one question answered (and maybe still didn’t get what the instructor is trying to convey). This is going to cause a lot of undo stress due to time lags, equipment availability, nuance, etc. Now multiply that by 30 students!

Another issue is with communication and intent of the communication. Here we see the complaint from students

The students criticized Dr. Jones’s decision to reduce the number of midterm exams from three to two, flattening their chances to compensate for low grades. They said that he had tried to conceal course averages, did not offer extra credit and removed Zoom access to his lectures, even though some students had Covid. And, they said, he had a “condescending and demanding” tone.

Dr. Jones had responses for each of these (exam dates too early in the semester, lab scores which were not completed, etc.). Are both of these groups correct? Likely, yes. However, an interesting quote from his teaching assistant

I have noticed that many of the students who consistently complained about the class did not use the resources we afforded to them.

We also see that students were a bit unhappy with Dr. Jones attitude

Several of them said that Dr. Jones was keen to help students who asked questions, but that he could also be sarcastic and downbeat about the class’s poor performance.

This is one of the more challenging issues facing instructors. How do you use class performance which is underwhelming to motivate students to do better going forward? If you ignore it, they will assume that it is normal. If you address it poorly, you’ll harm yourself (been there, done that). The key is to say that you know performance was worse than expected and here is how we (both you and them) are going to improve it. Easier said than done, but an important tool in the instructors tool kit is to know how to be “disappointed” in the performance but “excited” about the opportunity for improvement. We are going to work harder going forward! This is a legitimate possibility (at least for some of the students).

One drawback is the perception of difficulty is being determined by students. As Nathaniel J. Traaseth (a chemistry professor) stated

“Now the faculty who are not tenured are looking at this case and thinking, ‘Wow, what if this happens to me and they don’t renew my contract?’”

Does this imply that we are going to see teaching standards stay difficult? Are instructors going to need more student-pleasing attitudes (aka better PR strategies without weakening demands)? Or are we going to make classes easier to appease angry students and parents? I know which path I’d rather see, but accomplishing it is hard. My former school has seen full-time equivalent enrollment drop by nearly 20% over the past five years (this is only one of the reasons)! Addressing this (and other challenging environments) are one of the many reasons that I would not want to be in the shoes of administrators that need to fix the problem. It’s Freakin’ HARD!

While we all think it’s better to focus on where the students will be throughout their life, it doesn’t solve the problem of who’s paying tuition today. I’m not sure what the best solution is, but know that higher education needs to figure it out before another 10+ years go by or the situation is going to get worse.

And wasn’t it great to watch some NFL Football last night?

I’ve decided to give away a second one-month subscriptions to Liberty Highlights. Last week, we did the first, this week we’ll do the second. If you are interested, please send me an email or reply to this forum and I will randomly pick a winner. I’m going to mention this again in a minute as I’d love to hear from you regarding the content of the past five episodes. Here is the random drawing for this week’s drawing.

If you didn’t win, jump in for the next one!

Down Time

I’m also ready for a small break. It could be a month or it could be two. However, I’m running out of stuff to talk about (apparently it’s not like a normal semester where I get to just repeat stuff on a regular basis 🤣) and feel like it’s time to rest up (and watch some football).

Disclaimer — This is an informational process and is not designed to tell you whether or not you should buy Gladstone Land Corporation (LAND 0.46%↑). Instead, it is designed to show you how I would go about the evaluation and what questions I have. DO NOT USE THIS SERIES TO MAKE A BUY/SELL DECISION!

Note that this is a different, multiple part (maybe too much) attempt to look closely at a company. Please let me know what you think and feel free to offer suggestions for improvement.

Second Quarter Overview and Recap

It’s time to wrap up our Gladstone Land review with a look at the 2nd quarter of 2022 (which ended in June) and close with a “what we learned” overview. If you liked this series, please let me know. We can follow it up with a review of Howard Hughes Corporation and I can do these more frequently. If you didn’t care for it, let me know that as well and we can return to regularly scheduled programming. Remember that I’ll be gone for a month or so, but hopefully there will be some feedback to help provide some guidance. Feel free to send an email or, better yet, reply in the comment section.

Conference Call Overview

You can see the conference call transcript here if you’d like to follow along. I’m going to go through this as it unfolded instead of picking highlights and discussing them out-of-order. Unless otherwise stated, assume the quotes come from David Gladstone.

We currently own over 115,000 acres of farmland in the United States and 169 farms. And in addition to that, as some of you will remember, we have 45,000-acre feet of banked water. An acre foot is equal to 325,861 gallons of water. That pencils out to about 14.6 million gallons of water that we have stored in the ground. And together, those 2 are valued at over $1.5 billion for this quarter end.

This refers to the total farm net asset value of $1,501,880,000 from their 2nd quarter update which worked out to $15.60 per share.

Our farms are in 15 different states, and more importantly, they are in 29 different farming areas. Farms continue to be 100% occupied and leased to 90 different tenant farmers, all of whom are unrelated to us. And the tenants on these farms are growing over 60 different crops.

This is an important aspect of Gladstone Land in that it may not be truly diversified geographically (remember that California and Florida account for the vast majority of their land), they are spread out across crops and growing regions. Therefore, they do provide effective diversification in general. Also, their farms are 100% occupied. This speaks well for their ability to generate dependable cash flows from their assets.

We are much more selective in the type of farms that we're looking to buy. In light of the uncertainties in the economy, we believe it a good time to be more conservative with our capital. The team purchased 5 farms of about $60 million this year.

One of the major purchases was the $37.3 million purchase of vineyards in Washington and Oregon (1,317 acres of farmland) for $28,322 per acre.

We continue to be able to renew all expiring leases without incurring any downtime on any of the farms.

This is another positive sign that speaks well of their management team and advisory board. When you are making your money from leasing farms, you want to be able to renew leases quickly and easily. It appears that Gladstone Lands is accomplishing that goal!

The latest headline inflation number of 9.1% shocked us all, obviously. It is the highest in nearly 43 years. In the category though, which is called food at home, that category was up 12.2%….Farmers are adjusting to the changes in our economy as many of their input costs are increasing. First of all, the banks have increased the interest rates on all these lines of credit that farmers have, which they draw down when it's time to plant their crops. And then they also draw down additional funding from the banks for harvesting cost. And then, of course, there's all kind of things that they do during the year that they need extra money before they start harvesting. Farmers are also paying much more for fertilizer.

In other words, while increasing price for farm produce is good for farmers, it is being offset by increasing farm production costs. If the farm produce increases by 4% per year while farm production costs increase by 2%, this is great. On the other hand, if farm produce increases by 8% while production costs increase by 10%, this is not so great. Farmer’s need to make money in order to continue to engage in the business.

Currently, we have 2 farmers who are slow on their paid rent. It's below 3% of our rents.

This is not surprising given the inflation in the farming community. Remember that they have 90 different farmers, so this represents about 2.2% of their farms.

In the meantime, we're looking for ways to adjust our overall cost of capital to better match the changes that we're seeing in the farmland acquisition market. Our issue is that our preferred stock and our borrowings have both become expensive for current farmland prices and rents. We have lines of credit. We're not using them. We've left them all fallow and just no reason for us to draw down money and put it to work if we can't put it to work with some spread from what we're paying to the money that's coming in. We're currently discussing internally a strategy for better managing our cost of capital. And if we make some big changes, we'll be back to you on that.

This is an important warning as it illustrates that one of the big advantages of Gladstone Lands is the cost of capital relative to Return on Invested Capital. Their costs are rising relative to what they can earn which reduces the potential income of their operations. This is likely one of the reasons why the stock price has dropped from almost $42 to $23 over the past few months.

During the second quarter, our team acquired one farm in California for about $25 million. In addition, right after the quarter end, we acquired 4 more farms in Washington State and Oregon. We paid about $37 million for that. Overall, the initial cash yields to us on these investments is about 6%. In addition, all the leases on these farms contain certain provisions such as participation rents or annual escalations that should push that figure higher as we move forward.

Keep in mind that the Series B, C and D Preferred is trading to yield about 5.0-6.0%, so after expenses, there isn’t really a profit immediately on the new purchases. However, the participation rents, annual escalations, and increasing property value (assuming it does continue to increase) should generate profits before long. Also, some leverage could help boost returns a bit.

On the leasing front, since the beginning of the second quarter, we renewed 2 leases, which in total are expected to result in increase in annual rent and operating income for us. About $179,000 based over the prior leases that we had on the property.

And looking ahead, we only have one lease scheduled to expire in the next 6 months, and that makes up less than 1% of our total annualized lease revenue. We are in discussions with potential tenants for this farm, and we aren't currently expecting any downtime on that.

So leasing activity is not very active, but appears to be going smoothly.

The next paragraph is a discussion of the drought out West in California (it is real), but is not hurting their properties at the moment.1

All of our properties in California continue in the position where the farmer has enough water to complete the current crop year. Of course, we never know what next year is going to look like, but water remains a premium out West.

There is also a discussion of property values not necessarily reflecting the current market pricing.2

The appraisal values aren't moving very fast though, as quickly as I would like them to pick up the current prices we're seeing…Their values can be sometimes lagging quite a bit.

The final bit is about their ESG (Environmental, Social, and Governmental) approach in that they are in the process of adding some solar/wind arrays on their properties. However, he (legitimately) is in a position where his first priority are the tenants (who lease the property). This makes perfect sense in that you need to be able to convince the tenants that the environmental push is to their benefit, not their detriment.

We always want to be careful that we enter into agreements that aren't going to disturb our tenant. Well, maybe a small disturbance, but tenants currently on our farm because that's our primary business partner is the tenant. Not the guy who's going to put some solar arrays on the property.

Operating Updates

We move from David Gladstone to Lewis Parrish for some operating information.

During the quarter, we received about $5 million in loan proceeds. Those proceeds are expected to bear interest at an effective rate of 2.89%, which is fixed for the next 5 years. On the equity side, since the beginning of the second quarter, we've raised about $70 million of net proceeds from sales of the Series C stock.

The cost of debt is relatively cheap (2.89%), but the ratio of debt to preferred is probably more important. If the firm raised $75 million in financing, but only $5 million in debt, that works out to 6.67% debt financing vs. 93.33% equity financing. Unfortunately, the equity is higher (we don’t know the price, but assume it is 6.0%), that would bring their cost of capital to 5.79% (an approximation because Series C is not quoted).

Numbers from the 2nd Quarter include:

• Net income of about $613,000

• Net loss to common shareholders of $3.9 million or $0.112 per common share (remember that these are not similar to earnings from a company)

• Adjusted FFO for the second quarter was approximately $4.5 million ($0.129 per share) compared to $6.4 million ($0.185 per share) in the first quarter

• Fixed base rents increased by $320,000, core operating expense decreased by about $1,000,000

• Sixty-one farms were valued showing an increase of about $500,000 from the previous year. This lead to their NAV coming in at $15.60

• Their loan-to-value ratio on their net holdings is 38%. Of the debt, 99% are fixed rate with the rate fixed for the next 5 years. The current yield is 3.26%

• They currently have about $55 million in loans coming due over the next 12 months, but only about $24 million is likely to need paid. They currently have $135 million in purchasing power, so debt due is not a problem

• Their dividend is set to $0.0456 per month. While they make a point of saying the dividend has been “raised” 27 quarters of the past 30 quarters, the raises have been pretty small as it has gone up by 52% over that time frame.

Note the slow growth of dividends from 2018-2022. Dividends grew rapidly during the first 3 years before slowing dramatically over the past 5 years.

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Question and Answer Session

Next we go to the Question and Answer session. However, before that there is a general commentary by David Gladstone.

The NCRI Farmland Index, which has about $14.6 billion worth of agricultural properties, including all of those that we've listed with them so that they have ours as well as others in the business, have been averaging about a 12.6% overall return over the last 20 years with no negative years. As you may know, some of the indexes have gone negative during the year. This is higher than both the S&P Index and the overall REIT Index, both of which have had 3 or 4 negative years in the same periods of time. Versus 0 for Farmland Index.

This is a little misleading in that Gladstone Land had negative returns in 2014-2015 and is on track for one in 2022 (although there is still plenty of time that could change).3 Therefore, while farmland itself has exhibited no negative return, Gladstone Land has done so in 3 of it's 10 years. Granted, it is still up by 133% over the time frame, however, that does pale in comparison to the S&P 500 which is up 215% over the same time.

One, it's similar to hard assets like gold. After all, farmland is mostly just dirt. And that's an intrinsic value because there's a limited amount of good farmland and it's being used up. It's an active investment which cash flows come in to investors. We expect inflation, particularly in the food sector to continue to increase, and we expect the values of the underlying farmland to increase as a result.

I don’t disagree with either of these two statements, which is why I do have exposure to farmland in my portfolio. The key is to figure out which is the best way to gain exposure to the asset class.

The first question is what has happened to the price of farmland and the availability of farmland? The answer is that it is up 20% (which I’m guessing is a ballpark estimate) in the last year. As for availability, he answers as follows.

If you're in California or Florida, there's not that much in the way of any auctions. We've been to one that I remember in the last 20 years. It's a fairly dominant marketplace for those who will figure out what might be for sale. And so that's what we do. We go to the farmers, talk with the farmers and spend time with the farmers. We get our best chances is when one of our farmers will call up and say, Joe next door is thinking about selling his farm, but I don't have the money, would you buy it and let me rent it? That's where we've concentrating on talking to farmers. I think our guys are on the phone with somebody every day trying to figure out what might come up. And when it comes up, there's at least a 50-50 chance that will be priced in a way that we won't be able to compete because our cost of money is too high. As a result, we're in touch with a lot of the people there. can't give you, Rob, I just can't give you much in the way of what a farm would go for today, but we're buying them. We spent $37 million at the end of the year to buy farms in the State of Washington and in Oregon.

Let’s break this down a bit. Essentially the answer is there is not a lot of available farmland and it takes quite a bit of effort to broker a deal. There is some availability, but it is largely overpriced and out of the range at which Gladstone Lands is willing to pay. Part of that is due to their cost of capital. However, they do still do deals when conditions present themselves.

The next question (still the same analyst) asks about wind turbines and solar panels. This was mentioned earlier in the call. The answer is largely that they do put them in when it makes economic sense. However, it is not clear that David Gladstone is a huge fan of the environmental benefits of renewables.

I think at the end of the day, when you look at these turbines and all of those, those are wonderful ways to capture the wind and capture the sun, but they're not going to take over for quite a while as a mainstay for us or anybody else to generate electricity.

The next question had to do with participation rents. These are rents in which Gladstone Lands gets to participate on the upside of the harvest assuming it generates enough money.

I think we have about 40 farms that have participation rent components. I'd have to go back to the 10-K to see what it was for '21. But as I said, we are expecting it to be up, and that's largely a factor of a lot of the farms we purchased recently. They're either coming into full maturity or that participation rent component is now coming online for the first time this year. Or just it's additional farms we bought in the past couple of years.

Does this answer concern anyone? First, according to the 10K, there are 35 farms with participation rents. Maybe they are including new purchases, but the difference between knowing how many farms pay participation rents is 35 or 40 seems meaningful.4 Also, the income statement shows that for the first 6 months of 2022, the participation rental income was a mere $20,000 out of $40,210,000. That is 0.05%!

Combine that with the answer either a lot of farms “we purchased recently” or farms “we bought in the past couple of years,” makes you wonder how much time the CEO/President put into preparing for this call.

The next question comes back to wind turbines and solar arrays. David Gladstone replies

Because stockholders, at least some of them, are demanding that they move in that direction. We are getting better deals than we got 2 years ago and I think it will keep going that way. Probably cover the whole nation with wind power one day. We'll be like the guys in Europe who are putting up all of those things.

And I think they'll, quite frankly, I think they'll put more wind turbines up off the coast like in Massachusetts where you can see them from the beach and people are excited about that. And I think it's going to be a while before we get a lot. I don't know what it is, is it 9% now that we've got wind or solar that's producing for us? And of course, we're one of the few nations that do that kind of stuff. As a result, there's other countries where they're still burning lots of coal. Like China, I think they open up a new coal mine every week. As a result, I don't think we're going to do much for the world in terms of shutting down the use of all of these things that put so much dust in the air.

It’s a text transcript and I’m not listening to the actual call, so I might be missing the tone of his comment. Maybe he seriously is a fan of alternative energy. However, I get the impression that this is more of an inconvenience that they are dealing with rather than a chance to improve the energy situation (which may be valid as I don’t know the economics). Alternatively, this seems like a positive comment

Usually, they can do it in an off-season, so it doesn't disturb them and that works. And during the season, unless the wind is really making a lot of racket with the wind mills, it's nothing. You don't want to put them too close to houses because people don't want the noise. It's a developing area, and like all development areas, we don't know what's going to happen. We know there will continue to be pressure to move more and more toward those and hopefully we're the beneficiary of that.

The last question is on what is expected with rents and pricing going forward. His response is positive saying that he expects “We'll get many more increases than we will decreases. As a result, I think you should be bullish on that area of increasing rents.”

Beta and Past Performance

One statistic that is mentioned in Gladstone Lands presentations is the performance of the NAREIT Farmland Index. For the last 20 years, the Farmland Index has earned a higher rate of return than the S&P 500 (12.6% vs. 11.1%) with less risk (7.4% vs. 17.1%). These numbers are likely valid. However, the cost of managing a farmland REIT (like Gladstone Land) is going to reduce returns and increase risk. For the last 5 years, the risk of Gladstone Land has been much higher than the S&P 500 (31.6% vs. 20.0%). The same is true for the past 3 years (36.8% vs. 22.7%).

From a return perspective, the return on the Gladstone Lands stock price over the past years tells a different story. It has been higher than the S&P 500 over the recent past (15.7% vs. 11.7% over 5 years and 17.5% vs 7.2% over the past 3 years). The correlation of Gladstone Lands to the S&P was 0.47 and 0.53. Beta was less than one in each case with 0.74 (5-year) and 0.86 (3-year). This implies that LAND is less risky than the market by a small amount over the recent past.

Recap of Gladstone Land

Again, I want to stress that this is MY opinion on Gladstone Land. It may be too conservative or too aggressive for YOUR investment approach. Do not try to apply my views to your investment strategy. Heck, as I’ve mentioned a few times, the best strategy is to invest regularly in an ETF/index fund in your IRA (Roth or Traditional) or 401k (Roth or Traditional). Save as much as you can afford and only look at the account about once a year to rebalance to your preferred risk. Your 30-minute per year plan will provide plenty of time for hiking, playing reading books, playing golf or working on your Salsa dancing (or any of 100 other hobbies you may be pursuing). Only if you enjoy brain damage should you try to manage your own investments.

Advantages of Gladstone Land

• Probably the major advantage to investing in Gladstone Land is access to farmland in your portfolio. There are other ways, but only two farmland REITs trade publicly that I’m aware of (the other being Farmland Partners (FPI)). So unless you have the wealth/income for personalized investments this is an easy way to get exposure.

• Taking it one step further, Gladstone Land does provide diversified exposure to more permanent crop (as opposed to annual crop) farms. These offer a little higher return on average (year to year fluctuations aside).

• Diversification. By buying Gladstone Land, you do not have a major concern about something happening to a single farm. They have over 160 individual farms and perform diligence on both the farmland selected and the tenants. While it is hard to argue that Gladstone’s advisory team provides extra assurances, it is also hard to argue that it doesn’t provide meaningful protection for investors.

• Performance has been good over the past 3-5 years. If you look at total returns (even with the tough year that Gladstone has had this year), they are handily outperforming the S&P 500 in terms of return with slightly less than average risk. Granted, a portion of that is due to good conditions for farmland. Rates were low for awhile and as rates rose, so to have food prices. Unfortunately, we don’t know what the next few months (or years) are going to look like.

Disadvantages of Gladstone Land

• Advisory fees are high and there are significant agency relationships. Not only does Gladstone Land charge relatively high incentive fees, but they also have cross-connected relationships, lack of shareholder influence on the board, and other potential agency conflicts. While they may be above-board on all these issues, the lack of ability for shareholders to do much opens up risk.

• It is a competitive market. Farmland is not a unique product that Gladstone Land is running. It has an active secondary market with many institutional players. Therefore, there is unlikely to be a sustainable advantage provided by Gladstone’s advisory board. Instead, you are likely to earn farmland returns less the management costs of running the company (base management fees, incentive fees, overhead costs, labor expenses, etc.). If farmland itself earns a 12% return, you are likely to average a 8-10% return. If farmland earns an 8% return, your are likely to average closer to a 6-7% return. This includes the leverage component which is helping to boost your returns.

• It likely got a bit ahead of itself. While I believe that the NAV is likely understated, the NAV went from $14.31 in 2021 to $15.60 in the last 2 quarters (about an 18% return). If the true NAV is somewhere between $15.60 and $20.00, this still places Gladstone as a bit overvalued. Also, the FFO per share for the first 6 months of 2022 is $0.33/share. The stock price is at $22.98. This means that even if the next 6 months generates $0.40/share, the stock price is trading at 31.5 times “cash flow”. Granted, maybe it grows faster, but it is still pricey relative to both NAV and FFO.

• Complex financing. While preferred and debt are common among REITs, it does make it harder to understand the company’s financials…especially when one of preferred share classes is not publicly traded. They also have several pieces of debt. While they do provide great information on this, it is tricky to understand and follow along. It also gets confusing as FFO overall can go up a lot faster than FFO/share (again, consider 2021 where FFO increased at a 45% rate while FFO/share growth was just a touch above 6%).

Takeaway on Gladstone Lands

My takeaway is that Gladstone is a mediocre investment. I like having some farmland for the diversification, but keep in mind that you aren’t owning just farmland. You are owning a REIT that OWNS farmland. The payoff pattern is quite a bit different. Over 10 years, you’ll probably earn the return of farmland less about 2-3% in operating expenses. Your risk will be a little higher as the REIT will move with the S&P a bit more than normal (due largely to psychological issues). If it had no diversification benefits, I would not own any Gladstone. I actually own far less of it due to my AcreTrader investments (which offers a slightly lower cost of ownership). Would I purchase more if the price point dropped down to $15-$18 and the business stayed stable or improved? Sure. However, the current price is too high to commit more capital.

Please Leave a Comment

I mentioned this above, but let me close with a final request. Did you like the in-depth look at a single company? Are there things you would like to see me do differently going forward or follow the same basic framework? If you’re indifferent, that’s fine. However, if you have a preference, please take a second and leave a comment! This will allow me to know how to direct the discussion going forward.

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I’ve decided to give away two one-month subscriptions to Liberty Highlights. Technically, it is free, but he also offers a subscription. Same content, but he’s trying to justify the work (and trust me, it’s a lot of work) with a subscription fee. Somewhat like a “Let me tell you some stories and hopefully you find it worth a small fee, but if not enjoy the stories.” His goal is a 5% subscription rate, but lately it’s down closer to 3%. So, let’s get the word out. We’ll do one this week and one next week. If you are interested, please send me an email saying “I’m interested” or reply to this forum and I will randomly pick a winner (winner will be selected Monday morning).

Disclaimer — This is an informational process and is not designed to tell you whether or not you should buy Gladstone Land Corporation (LAND 0.46%↑). Instead, it is designed to show you how I would go about the evaluation and what questions I have. DO NOT USE THIS SERIES TO MAKE A BUY/SELL DECISION!

Note that this is a different, multiple part (maybe too much) attempt to look closely at a company. Please let me know what you think and feel free to offer suggestions for improvement.

Other Risk Factors

After a LONG post on business risks associated with Gladstone Land, I decided having back-to-back posts on other risk factors might cause a round of head injuries from readers falling asleep onto their keyboards. While risks are important and worth spending some time with, they can also be a bit monotonous and repetitive. Therefore, I switched it up and went with a valuation topic last time around.

Doing this made me a bit wary about how much Gladstone Land I held. Therefore, I did decide to liquidate a sizeable chunk (probably about 45%). I do have other access to investing in farmland (Acretrader), own other REITs (such as Iron Mountain Inc., Innovative Industrial Properties, etc.), and real estate (Fundrise and TIAA Real Estate). That said, none of those are recommendations to buy/sell positions. Please do not blindly follow me into investments as our age, income and goals are all very different.

Now, back to more risk issues.

Advisor Risk Factors

Let’s take a look at the six risks associated with having an advisory service that recommends investments. Again, this is not to say that the firm is wrong to provide payment for advisory fees as someone is doing the legwork to find farms, tenants, and bring these parties together in a way that allows Gladstone Land to be profitable. They deserve compensation for their efforts. As of now, this includes a base fee plus an incentive fee on each deal that earns over 7%.

The first risk factor is that it is a small group of people that are largely responsible for finding and negotiating opportunities for Gladstone Land. However, there is a risk of what happens if something were to cause one of the key players to retire, have a health risk, etc. Fortunately, this is no different than any other key corporation and most have plans for replacement. Probably the biggest risk here would be to CEO/President David Gladstone.

The second risk factor has to do with adviser board competence. As stockholders, you are reliant on the advisory team to be good at what they do. If not, you may see leverage ratios get misaligned (too low or too high), poor investments, contract issues, inferior tenants, etc. Fortunately, we have the ability to monitor how well Gladstone has done with this in the recent past and the verdict is positive. They have not lost money in any given year and even managed the COVID situation positively. This is not to say that they are perfect as there is only one other farming REIT to compare them to (Farmland Partners which is up about 92% over the past 5 years). Gladstone Land during that time is up about 110% over the same time frame. The S&P 500 is up 78.4% during those same 5 years. Unfortunately, we don’t really have a lot to compare returns to in order to measure how well Gladstone Land has done.

The third risk factor is essentially an agency relationship issue. An agency relationship refers to a situation where one party (the agent) hires another party (the principal) and then grants the principal decision-making authority. This works well in certain situations, when the goals of the principal and agent are aligned. It works poorly when the goals of the principal and agent are poorly aligned. Here, there is a legitimate question regarding how well the advisory committee is aligned with the shareholders as the advisory committee is employed by Gladstone.

At the same time, our Advisory Agreement permits our Adviser to conduct other commercial activities and to provide management and advisory services to other entities, including, but not limited to, Gladstone Commercial, Gladstone Capital, and Gladstone Investment, each of which is affiliated with us.

We also see this

Examples of these potential conflicts include:

• our Adviser may realize substantial compensation on account of its activities on our behalf and may be motivated to approve acquisitions solely on the basis of increasing its compensation from us;

• our agreements with our Adviser are not arm’s-length agreements, which could result in terms in those agreements that are less favorable than we could obtain from independent third parties;

• we may experience competition with our affiliates for potential financing transactions; and

• our Adviser and other affiliates, such as Gladstone Commercial, Gladstone Capital, Gladstone Investment, and Gladstone Acquisition could compete for the time and services of our officers and directors and reduce the amount of time they are able to devote to management of our business.

In other words, there is legitimate concern that the advisers could be acting in the interest of one of the other Gladstone companies (or a different company) that conflicts with shareholders of LAND. While it is wrong to assume that the advisory board is intentionally trying to cheat LAND shareholders, it is not wrong to assume that there is potential for situations where priorities are in conflict (despite the best efforts of Gladstone) and this opens up a significant agency conflict.1

The fourth risk is more boilerplate than anything. Technically, the company could have opportunties that it bypasses because there are not enough people to do the job or are ineffective at their job. That said, this is no different than any other company.

The fifth risk is important because I don’t see the last time that the incentive fee was waived (it is possible it was done before 2020).

The Advisory Agreement contemplates a quarterly incentive fee based on our funds from operation (“FFO”). Our Adviser has the ability to issue a full or partial waiver of the incentive fee for current and future periods; however, our Adviser is not required to issue any waiver. Any waiver issued by our Adviser is an unconditional and irrevocable waiver. If our Adviser does not issue this waiver in future quarters, it could negatively impact our earnings and may compromise our ability to maintain our current level of, or increase, distributions to our stockholders.

While they may have the ability to waive the incentive fee, it does not appear to be happening currently (if I'm wrong, please let me know as I'd rather be correct than right). Which means that in 2021, the firm paid $6,329,000 in base management fees, $3,901,000 in incentive fees, $1,526,000 in administrative fees, and $4,675,000 in operating expenses. They generated $75,318,000 in rents/leases, so their total cost is 21.8% of rental fees (5.2% incentive fees). In this situation, I’m presenting numbers because it is good to understand the costs. If the firm generates a 10% return, that will fall to 9.4% from base fees and another 2% (1.75% on the difference between 7% and 8.75% + an extra 0.25% on the difference between 10% and 8.75%) to earn 7.4% total.2

The sixth risk is similar to the mutual fund rule. You can owe taxes on a mutual fund (assuming it is in a taxable account) during a period in which you lose money. The reason is the way dividend and capital gains taxes are determined. Assume you earn a 2% dividend and have $100,000 in AGI (single) so you are in the 24% income tax bracket, you’ll pay 15% in taxes. So, if you earned $2000 in dividends, you get to keep $1700 and pay $300 in taxes.3 If they distribute capital gains and do so randomly, they could report capital gains of 10% (by selling their "winners"), even if they lose money. Gladstone is warning investors that the incentive fee is based on individual properties and they could take losses overall due to other factors.

Risks With Ownership of Common Stock and Tax Status

In addition to risks associated wtih the advisory nature of Gladstone Land, there are also risks associated with the structure of their securities, both preferred and common.

The first of these risks is that effectively the company is structured to avoid acquisition. Therefore, even if an institutional investor thought that Gladstone Land was being run inefficiently, there is little that they could do to make it more efficient.

Our articles of incorporation prohibit ownership of more than 3.3% of the outstanding shares of our capital stock by one person, except for certain qualified institutional investors, which are limited to holding 9.8% of our common stock.

In other words, it would be impossible to acquire a large enough stake gain control. In addition, they have a staggered board and the only reason for removal of a board member is for cause. Finally, a discouraged stockholders would need approval by two-thirds of the other shareholders. In other words, the chances of a hostile takeover are VERY, VERY small.

The second risk merely states that, barring a nearly criminal act by directors (only a slight exaggeration), shareholders have little recourse for protection.

The third risk factor is clearly less relevant. Essentially, it states that the firm can use Operating Partnership agreements that can make it difficult to sell properties at opportune times. That said, the firm states that it does not any of these OP pieces in place.

The fourth risk is directly related. If they were to enter an OP agreement, then the other party in the OP could force the firm to buy out their shares. Again, there are currently no Operating Partnerships in agreement. Is it a real risk? Sure, it COULD be, but it is not currently an issue.

The fifth risk is that the firm has issued preferred B, preferred C, and preferred D shares. This is not uncommon among REITs as many use preferred stock as a form of financing. What is a bit uncommon is that

Under our charter, we currently have authority to issue shares of both common stock and preferred stock (inclusive of our Series B Preferred Stock, Series C Preferred Stock, and Series D Term Preferred Stock). Our Board of Directors has the authority, without a stockholders’ vote, to classify or reclassify any unissued shares of stock, including common stock, into preferred stock (or vice versa), to increase or decrease the authorized number of shares of common stock and preferred stock and to establish the preferences and rights of any preferred stock or other class or series of shares to be issued.

Essentially, this gives the Board of Directors the right to manipulate the shares of stock outstanding to control voting rights. It is doubtful that this would occur given the difficulties of an interested party taking control of the firm (see risk one of the ownership structure), but is yet another potential hurdle which illustrates that common shareholders have essentially no control (which goes back to the shareholder rights score of 9/10 (where 10 is the worst score) and Board of 10/10.

Share

Here are the next set of risks associated with ownership of common stock and tax status.

For the first one, let’s take a second to reintroduce the three primary types of preferred stock outstanding. You can see the full documents of Gladstone Land preferred shares on this page. Essentially Series B Preferred shares were issued in May 2018 with a 6% dividend and $25 par value (for a dividend of $1.50 per year), Series C Preferred shares were issued in February 2020 with a 6% dividend and $25 par value (again $1.50 per year), and Series D Preferred shares were issued in January 2021 with a 5% dividend and $25 par value (for a $1.25 dividend). These shares trade for around $26.50 - $27.00 per share for the Series B and $24.50 - $25 per share for the Series D (Series C is not publicly traded).

As is common, preferred dividends are paid before common and could result in the firm paying more in preferred dividends than it generates in cash flows in a given period. That said, Funds From Operations (FFO) has been positive every year since 2014 and has grown from $1,160,000 to $21,010,000 during that time (along with a lot of new shares being issued). The chance that preferred dividends will eat into Gladstone Lands cash flows to the point of using all the cash flows is, once again, not a reasonable concern. Again, it is one of the things that COULD happen, but is not something that will keep me up at night worrying about happening.

The seventh risk is essentially restating the sixth. Again, not a concern I have.

The eighth through eleventh risk are all related to maintaining their status as a REIT. Essentially, this requires them to meet several requirements including distributing at least 90% of their income in the form of dividends each year and having 75% of their assets in real estate. There are also several other rules that focus on accounting issues. That said, there are lots of REITs out there and all of them have similar disclosure agreements. It is hoped that their accounting departments are well aware of the requirements and working with management to make sure that they are on the right side of the REIT structure rules. If so, then none of these issues will be a major problem. The eleventh issue is a tax code on dividends that states that dividends for REITs are taxed as ordinary dividends (not qualified) and therefore at a higher tax rate (your ordinary income tax bracket) rather than the reduced dividend tax bracket. Therefore, if you are in the higher tax bracket range, you will be paying up to 37% (assuming you are quite wealthy) instead of the max of 20% on ordinary dividends. In other words, for every $1 you receive, you would get at least $0.63 instead of $0.80 as a worst-case scenario.

Here are the last set of risks associated with ownership/tax status.

The next risk is related to a rule for REITs which states that

To maintain our qualification as a REIT, no more than 50% of the value of our outstanding stock may be owned, directly or indirectly, by five or fewer individuals during the last half of a taxable year.

Given that they have strict rules in place to prevent this from happening (David Gladstone does own 8.7% of the shares as the largest shareholder), there is no real reason to worry about this.

The following risk is just stating that they do not intend to fight a letter from the IRS about REIT status. The next states that sale-leaseback agreements may be barred from REIT consideration. If this were to occur, it would kill half of the REITs out there. Frankly, I’m not sure why they are even listed as risks.

The next risk has to do with plan structure. The part that is confusing is that the REIT is listed as inappropriate for an IRA and I own it in my IRA. I did a little digging and found this statement:

What most RIAs would advise their clients to invest in, though, are real estate stocks, real estate mutual funds, and REITs. Of the three, REITs are the most common because there is a significant advantage for real estate firms to structure themselves this way: They aren't taxed at the corporate level. Like limited liability corporations, income isn't taxed until it's paid out to shareholders.

So, again, I’m not sure what the purpose of this warning is.

Jumping to the following risk, we see concern about operating partnerships which is a common structure in REITs. Essentially, they are saying that IF the IRS were to challenge the structure it could result in problems, but the chances of it happening are not on the radar.

Gladstone uses a Taxable REIT Subsidiary (TSR) structure in their REIT. This allows them to reduce their tax burden and is limited to under 20% of REIT assets. They are in no danger of violating this agreement based on current operating conditions.

And finally, there is a risk that “legislative or regulatory income tax changes” could occur to REITs. This is true. It is also true that tax codes for any type of business could change. It does not imply that the changes are likely to occur or would be damaging. Essentially the last set of risks are throwing in the kitchen sink. They COULD happen, however are unlikely to and are likely not major problems if they do occur.

Risks Related to the Market for our Common and Preferred Stock

And, let’s take a moment to celebrate…the LAST SET OF RISKS!

Now, before getting TOO excited about this last set of risks, realize that they could have left all of them off without missing a beat other than maybe violating the secret handshake clause of a 10K (yes, I am making that up just to see if you’re still awake because I dozed off in the last set).

Yes, increasing the supply of shares can hurt the price per share assuming the market is not deep enough. An increase in interest rates can also impact the price of common (especially one that is based largely on a dividend yield). The third risk has a little validity in that if they were to issue debt, it would take precedence over the preferred shares, but that is true for any company. It feels like we’ve covered the fourth risk already…oh yes, the sixth and seventh risk of the previous section. I guess they really want you to know that not having money means you aren’t going to receive dividends even if it hasn’t happened.

The next risk is that Series C Preferred is not listed. It still can be bought/sold, but is more of a private market transaction which means you will probably take a bit of a liquidity hit. Here’s a tip…don’t buy Series C until it is listed. 🤣 You’re welcome! Oh, and the next risk is if the rest of the stocks disappear, they will be required to buy back the Series C Preferred. If this happens, accept that your investment in Gladstone Land went bust because that is about the only situation where all other stocks will no longer be traded. The last risk is somewhat relevant in that it essentially means that the Series B, C, and D Preferred are callable by the company. This would only be relevant assuming that they could refinance the preferred shares for enough of a savings to make the repurchase worthwhile. If that were to happen, you would probably see an increase in the common (which is what we’re actually covering in the first place).

Reviewing The Risks

Okay, we started with a column covering 37 different business risks. Then we did another column covering another 31 different risks related to advisery boards and common stock ownership, tax structure, etc. That is a set of 68 different risks related to this business. Does anyone know why investors don’t want to read through a 10K? It probably has to do with identifying any and all risks that management can think of (which unfortunately is still going to miss one or two important risks that no one is even considering at this point — again, go back to 2019 and what was the warning of COVID risks?) rather than covering all the risks. Primarily because no one knows all the risks.

Of the risks presented here, there are three that I think are most important.

1. The risk associated with advisers making the correct call on which farmland to purchase, at what price, and who to lease it to. These are all challenging decisions where an advisory service will have an edge. However, that edge is going to be eaten into on two fronts. First, there are more and more competitors looking for opportunities, which implies that there will be fewer lucrative to exploit. The second is the incentive fee (which can be high) and potential agency relationships across the various Gladstone companies. This additional competition and lack of arms-length processes creates concerns about the ability of the advisory board to look out for shareholder interests as their primary focus. It could be that they do so, but there are lots of temptations between their (principals) interests and shareholder interests.

2. The second major risk is that there is little motivational force provided by takeover. The structure of Gladstone Land is such that there is not much an institution could do in order to create a potential takeover threat. Gladstone Land has created a board structure that makes it difficult to push out directors or advisory members. This effectively allows Gladstone to double-down on their lack of corporate control oversight. The first and second factors are reasons why they are rated poorly in shareholder rights and board.

3. While the first two are the biggest, the third is related to their preferred/debt structure. Having 3 classes of preferred stock plus multiple loan agreements along with the ability to raise more money going forward, it is difficult to predict what will be left to common shareholders. So far, things have been successful (assuming you want exposure to farmland). However, if you look at the last two years (2020 and 2021), Funds From Operations have increased from $14,486,000 to $21,012,000 (a 45% increase) while Funds From Operations PER SHARE have increased from $0.65 to $0.69 (a 6.2% increase). The REIT is growing, but the value of the REIT per share is not growing at anywhere near the same rate.

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A reminder that next week we’ll be taking the week off for chemo. The plan is for two more episodes of Gladstone Land (another on risks and one that is designed to be a wrap-up of the process). We’ll see how that goes.

A quick update on some of the other things being written (with the recognition that I’m reading less than 1% of what’s being published), but if you don’t normally read Gurwinder, he recently made a great post on Stoicism. Essentially it focuses on distractions (I’ve found myself clicking on “news” links a lot less recently as these often turn into distractions) and separates them into desire, anger, and anxiety. It probably takes about 10-15 minutes to read (assuming you can avoid getting distracted 🤣) and is worth the time. I’m not a disciple of Stoicism, but can relate to a lot of the advice in the column.

Disclaimer — This is an informational process and is not designed to tell you whether or not you should buy Gladstone Land Corporation (LAND -0.86%↓). Instead, it is designed to show you how I would go about the evaluation and what questions I have. DO NOT USE THIS SERIES TO MAKE A BUY/SELL DECISION!

Key Terminology Differences

REITs are a bit strange. While we are still focusing on a discounted cash flow model, but our DCF model will be built a bit differently. Before we get to that, I want to introduce a few terms that you may or may not be familiar with.

FFO, CFFO, and AFFO — Funds From Operations

The first thing to recognize is that Net Income is not as important as it is with many firms because of the structure of the REIT. Instead, we introduce Funds From Operations, Core Funds From Operations and Adjusted Funds From Operations as alternatives (primarily due to depreciation and amortization issues). Here is Gladstone Land explaining the distinction:

Specifically, we believe that FFO is helpful to investors in better understanding our operating performance, primarily because its calculation excludes depreciation and amortization expense on real estate assets, as we believe that GAAP historical cost depreciation of real estate assets is generally not correlated with changes in the value of those assets, particularly with farmland real estate, the value of which does not diminish in a predictable manner over time, as historical cost depreciation implies. Further, we believe that CFFO and AFFO are helpful in understanding our operating performance in that it removes certain items that, by their nature, are not comparable on a period-over-period basis and therefore tend to obscure actual operating performance.

FFO starts with net income and then adjusts for amortization and depreciation. CFFO and AFFO add in a couple of additional items meant to help standardize from year to year.

FFO = Net Income + Depreciation + Amortization + Losses on Sales of Asset - Gains on Sales of Assets - Interest Income

CFFO = FFO + Acquisition- and Disposition-Related Expenses + Other Adjustments

AFFO = CFFO + Rent Adjustments + Amortization of Debt Issuance Costs + Other Adjustments

So, here you can see their FFO, CFFO, and AFFO on a total basis for the last two years.

Let’s walk through this a bit. In calculating FFO, Gladstone starts with their net income ($3,514,000). Then they reduce this by dividends paid to the Series B and Series C preferred shares (-$12,258,000) which leaves them $8,744,000 in the hole. However, since farmland actually tends to appreciate instead of depreciate, they add the value of of that back in ($27,183,000). In addition, they have losses on disposition of real estate assets ($2,537,000) and adjustments for unconsolidated entities ($36,000). Add these all together and we get $21,012,000 for the year, which is up considerably from the $14,486,000 from last year.1

The CFFO adjusts for other one-time expenses. It adds in any acquisition and disposition related expenses of $355,000 plus other nonrecurring receipts/charges (-$12,000) to give us $21,355,000.

The AFFO makes a couple of other adjustments for net rent (-$2,371,000), amortization of debt issuance costs ($1,172,000) and other non-cash charges ($246,000) which lowers the total to $20,402,000.

You can argue which is a better measure of cash flows (you can see the specifics on the bottom of p. 51-52 on how each is calculated), but they are all pretty close to one another. I’ll leave it up to you to decide which one you feel is most appropriate, but in the case of Gladstone Land, you’re not going to see major differences between the three.

Now let’s come back to the big jump in FFO/CFFO/AFFO from 2020 to 2021. It is largely an illusion. REITs need to raise capital to expand operations. Without issuing more shares (or more debt), it is impossible for Gladstone Lands to expand. However, they did expand because they issued quite a few more shares.

Specifically, the number of shares went from 22,389,866 in 2020 to 30,523,335 in 2021. This is a 36% increase in shares outstanding, which greatly eats into the more important FFO/CFFO/AFFO on a per-share basis. Specifically, the three numbers were up by only $0.03-$0.04 per share (FFO went from $0.65 per share to $0.69 per share). These numbers are rising, but are quite a bit smaller than they appeared to be based on the overall numbers. Always remember to adjust to a per-share basis when doing calculations!

Net Asset Value

Another key difference in REITs is that instead of book value, they have a Net Asset Value measurement. The NAV is designed to capture the fair value of the firm’s assets on a per share basis less any liabilities associated with the property. Here we can see the breakdown of the calculations.

They are “showing their work”. Specifically, how did they value the properties and the assumptions that were used. Purchase price refers to firms purchased in the last year are done at purchase price. Internal valuation is done for some properties (but only 3), and Third-party appraisals are done for those that were purchased beyond the last year.2

Next we make the necessary adjustments of liabilities and preferred shares to convert to a per share Net Asset Value.

This gives us the NAV of $14.31 as of the end of the 2021 year. Note that the actual price of the stock on this day was $33.39.3 This was quite a bit higher than the NAV.

Why is the stock price so much higher than the NAV? This is a good question that I don’t have a strong answer for. One could argue that Gladstone Land is being very conservative in estimating their NAV or that farmland is expected to increase in value at a much faster rate than other real estate. While the second argument does hold some weight, you could also make a strong argument that the stock price is simply overvalued.

Blue Vault Partners recently published a table of REIT stock prices relative to Net Asset Values and concluded that the NAV for Gladstone Land is quite a bit higher than it’s price (as in 98% of the NAV as of April 29th, 2022) and is the biggest differential between the price of the stock and the NAV.

Cash Flow and Net Asset Value Thoughts

If we look at Cash Flow (FFO, CFFO, and AFFO) and Net Asset Value, it is pretty easy to come to the conclusion that Gladstone Land is either pretty overvalued OR is expected to grow significantly going forward. If I look at a Price/CF value (price based on the close of 8-15-22), I’m going to end up with $26.10/$0.70 = 37.3X to $26.10/$0.67 = 39.0 Both of these numbers are pretty high unless cash flows are expected to grow significantly going forward. If we look at Price/NAV we get $26.10/$14.31 = 82.4% premium to NAV. Again, this is a steep price that is only justified if the cash flows keep growing and NAV keeps growing at a reasonably high rate.

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2nd Quarter Highlights

Fortunately, their 2nd quarter 10Q was just released this month. They added (over the first two quarters) 1 new farm (an olive farm in CA) of 1,374 acres plus a 15 acre farmroad. In other words, new acquisitions have been slower. This is not unusual as farm acquisitions can be a bit “clumpy”.4 Their FFO, CFFO, and AFFO are $0.33, $0.33, and $0.31 which indicates slight growth over the previous year ($0.30, $0.31, and $0.30). Their NAV has climbed to $15.60 per share. While this does reduce their premium ($26.10/$15.60 = 67.3%), it still remains relatively high.

Advisory Fees

Their adviser fees are separated into a base management fee and, each as applicable, an incentive fee, a capital gains fee, and a termination fee. There are also other fees associated with the property. Here you can see a breakdown of advisery fees for 2021 and the first 6 months of 2022.

Essentially, part of Gladstone’s revenues are channeled back into advisory fees to the tune of approximately $6M a year currently (based on the first 6 months of 2022). For the current year, their operating revenue is $40,236,000 and they are spending $2,974,000 (approximately 7.4%) in advisory fees (last year the number was higher as they earned $75,318,000 and paid $10,230,000 in fees for 13.6% rate). This is not a statement that the fees are too high or too low, merely a reflection of what they are spending. Keep in mind that the advisors are not meant to work for free and are providing a service to Gladstone Land for the work that they are doing. Instead, your decision as a potential investor is to figure out whether or not Gladstone Land is paying a fair rate, overpaying, or underpaying for these services. Given that the incentive fee gives them 100% of the return between 7% and 8.75% + 20% of the fee over 8.75%, you are losing quite a bit of your returns to incentive fees.5

Interest Expense

Remember that we mentioned one of the risks was related to leverage. The idea is that if Gladstone can borrow money at 3% and get a 5% return, they are finding extra money. For example, let’s say that I buy a property for $1,000,000 and negotiate a 5% lease rate. This will generate $50,000 for me (with the hope that the property will also generate a return from capital appreciation as a bonus…we’re going to ignore that for now). If I put up $700,000 to buy the land and borrow $300,000 at 3%, I’m going to still get the $50,000, but I’ll have $9000 in interest expense and get $41,000 on my $700,000 (increasing the return to 5.86%. If I put up $300,000 and borrow $700,000, I’m going to spend $21,000 in interest and get $29,000 on my $300,000 for a 9.67% return. It is easy to see how leverage can be beneficial. The downside is that spending on leverage is an expense (it NEEDS to be paid) and things could go wrong with my lease payment which creates the risk.

If we look at interest expense, it accounts for between $20,621,000 (out of $57,031,000 in revenue) in 2020 and $24,883,000 (out of $75,318,000) in 2021. This accounts for 36% of revenues in 2020 and 33% of revenues in 2021.

Preferred Dividends and Other Expenses

In addition to debt financing, they have preferred dividends (Series B and C) which get paid before common. These accounted for about 16.3% of cash flows in 2020-2021. It is reasonable to expect them to be about that much in 2022.

Other expenses (General and Administrative, Property Management, and Dividends on Preferred Series A and D, and Other) account for about 12.8% of revenues during 2020-2021. Note that this ignores Depreciation/Amortization. If we add up the expenses, we get about 35% for interest expense, 6.5% for other expenses, 13% for base expenses + incentive fees and 16.5% for dividends. This adds up to 71.0% for expenses, leaving approximately 28-30% for shareholders in terms of FFO (as it does not include the depreciation/amortization of property which is not a regular expense). If we split the difference and use 29%, we’d get an FFO of $21,842,000 which is slightly higher than the $21,012,000 for 2021. It’s not perfect, but the model projects about 28% for shareholders in 2021 instead of 29%…close enough for government work especially with the approximations that we’re using.

Valuation Summary

Valuation is hard to do and building a model for Gladstone Lands is probably not meaningful. The combination of depreciation/amortization and additional funding, makes projections pretty challenging (see above discussion). We’d need to know how much funding they are planning to use from various sources, what interest rates will be, and what they are planning to spend, what depreciation/amortization is going to look like, etc. Then, we’d need to project that out for the next 5+ years. The errors in the model are going to swamp the effort to build the model itself.

I’m also not going to tell you what I think Gladstone Land is worth. Partly that is to avoid looking like a complete idiot in the next 3-5 years, but largely it is because predicting the value of any one stock is not really possible. If you believe markets are reasonably efficient, it is probably reasonable to project a 7% return per year for the next 5 years which would put it around $33.31 (from today’s $26.10) given a 5% return + 2% dividend. If you project an 8% return, you’ll get a price of $34.93. In the last year, the price has ranged between $21.23 and $42.10, so you can see that predicting a price is pretty arbitrary.

In full disclosure, I did decide to sell 900 shares last week as I worked through the valuation analysis (I still own 1072 — purchased 1000 shares and have 72 additional shares from dividend reinvesting).

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Note that this is a different, multiple part (maybe too much) attempt to look closely at a company. Please let me know what you think and feel free to offer suggestions for improvement.

Risks Associated with Gladstone Land Corp

The next 11 pages deal with various business risks associated with investing in Gladstone Land. While, many of these are going to be “boilerplate” we are going to go through each one in varying degrees of detail.

These are the first three risks documented in the 10K. Yes, I know there are more, and don’t worry, we’ll cover them all (even one’s where you’re wondering why would they even put that in there) in this week’s update.

The first risk is geographic. While there are 50 states in the US (plus Washington, DC and some territories), Gladstone currently has property in only 15 of the states. You can see the states here (and bonus points — figuratively — if you can name each of them).

These states have different weather (a drought in California could be offset by a freeze in Florida), legislations rules regarding real estate are slightly different in each state, regulations on taxes are different, etc. Here is a breakdown of their geographic representation. As you can see, California and Florida are their biggest (by far) arenas representing 84.1% of their lease revenues. There are a lot of differentiation in types of crops, but overall your leases are tied to two states, which is going to increase the risk exposure.

Their second concern is that there may not be ample opportunities. This is probably more relevant as more commercial farmers are competing for farmland. In addition to Gladstone Land, you have AcreTrader (I do own farms through them) and many other private farmland investors.1 The more commercial enterprises competing for farmland implies far fewer viable investment opportunities for growth. Make sure you understand that tradeoff…this is not a get rich quick opportunity.

The third concern has to do with permanent crops that need developed. I invested in two of these in my AcreTrader account where they anticipate it will be a couple of years before cash flows are being generated. One is an apple farm where the investment closed at the end of March 2021 and the first (limited) harvest is not until 2025 (which will be limited) and the first full harvest is not expected until 2027. That means it will be 7 years before the first real returns kick in. A lot can happen to apple production, pricing, etc. in 7 years! This makes a higher risk investment. Fortunately, this appears to be more of a “cautionary” risk as the following line is in the 10K (emphasis added by me). Not to be dismissed (as it could happen), but not a current risk factor either.

All of our properties undergoing development or planted with immature permanent crops are currently leased and earning income. However, with regard to future acquisitions of such properties, the time frame required for development and for the farms to become commercially productive means that we may not be able to lease the farms and, in turn, generate revenue with respect to such farms for several years.

Here are the next set of risks mentioned in the risk category.

The fourth risk mentioned here is technically valid as no one knows what the future will bring. That said, their Q1 Conference Call states

Our farms continue to be 100% occupied and are leased to 86 different tenant farmers, all of whom are unrelated to us. And the tenants on these farms are growing over 60 different types of crops. Given the number of different growing regions, tenants and different tenants and different types of crops on our farms, we think there -- this is sufficient diversification to provide safety and security for the cash flows coming in from the rents. We believe these diversifications help protect the dividends that we pay to our shareholders.

There is also this line from a paragraph or two later

The tenant there wanted to see how it worked before he signed a long-term fixed rate lease. So we're going to get 80% of the gross revenue earned on the farm this year based on current commodity prices and yield estimates, we think we'll end up in a similar place, where we would have been in -- on the previous lease on this farm, but we will not know the results until the end of the year when the crops are sold. Excluding this one lease, our other lease renewals are expected to result in an increase in annual net operating income of approximately $55,000 or about a 3% increase over the old leases that we replaced.

These exchanges indicate that there are some potential lease issues that could arise. However, at the moment, they appear pretty small.

Regarding the cash dividends, it is important to note that their latest conference call includes the following

Finally, regarding our common distributions. We recently raised our common dividend again to $0.0454 per share per month. Over the past 29 quarters, we raised our common dividend 26x resulting in an overall increase of more than 51% over this time. Since 2013, we paid 111 consecutive monthly dividends to common shareholders, and our goal is to continue to increase the dividend at regular intervals.

and this

On a quarter-over-quarter basis, adjusted FFO for the first quarter was approximately $6.4 million compared to $6.7 million in the fourth quarter last year. And AFFO per share was $0.185 in the first quarter versus $0.199 in the fourth quarter '21. Dividends declared per share were about $0.136 in both quarters.

This indicates that while, again the future is unknown, the ability to pay dividends is not a major concern at the moment.2 While bankruptcy is a minor potential concern, it is more of a temporary issue (and one that Gladstone Land has yet to face) as their properties are such that a new tenant could be found without much difficulty.

Our next set of risks are here.

The first is a risk, but also an opportunity. Given higher inflation (especially in food), shorter-term leases can be as much a potential gain as a loss. If I purchased a piece of farmland and leased it out in January 2020 or leased it out in March 2022, I’m expecting that I’d get a much better deal on the lease in March 2022 than I would’ve in January 2020. Charlie Munger is famous for his “Invert, always invert” quote. Risk is one of those situations as well. The flip side though is we need to think not just about what is happening now, but what will happen over time (what if lease rates decline?).

The next risk is just a longer-term outlook on the previous. While some risks are short-term in nature, the opposite is a longer-term lease of 5+ years. Again, this is mitigated to an extent by rental rate escalations, but these are typically fixed in the contract. This is likely part of what has led to a decline in LAND’s prices over the past 6-months as property rental rates are rising slower than the value of the land itself. Fortunately, Gladstone Land owns the farms, so ultimately it is more of a short-term problem rather than a long-term problem.

While participation rents are a potential issue, these account for only about 25% of the farms (39) and about 30% of the farmland (34,477 acres).3 Therefore, it is probably not a major concern.

The last risk factor is probably one of the more relevant risks (and again, an opportunity). Permanent crops are higher risk, which means higher expected returns. If there is a problem with the crops (weather, disease, etc.) it is going to be more costly. There is also a more permanent nature of the plants (you can’t decide to replace your almond orchard with apple trees from one year to the next) which increases risk. How much risk vs. return are you interested in taking on?

The next set of risks are a mix of boilerplate with some real issues as well.

The first and second risks mentioned here are what are typically referred to as boilerplate. Yes, they are real risks, but they account for a very minor portion of the risk in Gladstone Land. It may be difficult to sell or re-lease property, but it is nowhere near an impossibility. You can see here that Gladstone Land has staggered lease termination (these are official, not an early termination which would be far more rare) to reduce the issue.

The one that is a bigger potential risk (especially given increases in drought conditions) is the potential lack of water. Granted, Gladstone Land looks at this as a major factor in acquiring land (see last update), but things do change. One way that Gladstone is addressing this is with the purchase of banked water resources at some of their properties.

During the year ended December 31, 2021, we executed all three contracts to purchase all 45,000 acre-feet of banked water for an aggregate additional cost of approximately $ 2.8 million.

This does not mean lack of water is going to disappear, but it appears that it is being addressed adequately.

The weather conditions issue has already been addressed. However, insurance does provide some protection (although prices may increase with poorer weather conditions going forward).

The climate change issue is a bigger problem. Unless you’ve been living in a cave for the past 20 years, you’ve heard about climate change. While it is not a universally agreed position it is hard to argue that regardless of whether this is a temporary fluctuation or a more permanent change, temperatures have been rising, oceans are warming, and ice sheets are melting, and snow cover is declining. Maybe this reverses and maybe it doesn’t.4 That said, climate issues are changing public behavior which will carry over to farming. This is an important risk that Gladstone Land will be facing, but again, it is also an opportunity for them. The question becomes how they will attempt to manage the risk. Will they overreact or underreact to potential changes?

Getting tired of risks yet? Don’t worry, we’re about halfway done. 🤣

These are all primarily focusing on the same aspect — the impact of financing availability through additional equity or debt (leverage). One important aspect of REITs is that they must pay out about 90% of their income each period in the form of dividends. This means that they are going to have very little in the manner of retained earnings to fund expansion. However, Gladstone Lands is expanding. So where are they getting the money to do so?

The first risk address the need to raise capital through equity (Series B preferred, Series C preferred, Series D term preferred) or raising debt in order to continue to fund growth. This is normally not a major problem, but could run into issues if the funding becomes more difficult. The second risk refers to the possibility of leverage (increasing debt obligations) which opens them to the same constraint. Currently, their debt costs are as follows

the weighted-average term to maturity of our notes and bonds payable was 9.8 years, and the weighted-average remaining fixed-price term of our borrowings was 5.6 years, with an expected weighted-average effective interest rate of 3.36% over that term.

It may be a bit higher now given rising interest rates, but probably not significantly.

The next three risk factors are not likely to be real important. Yes, they could have a bad year and need to cut dividends, but again that hasn’t happened in the recent past. Remember the dividend policy:

The Company has paid 110 consecutive monthly cash distributions on its common stock since its initial public offering in January 2013 and has increased its common stock distributions 26 times over the prior 29 quarters.

As for too much leverage, that is one of the points of the business is that they should not overextend themselves. History has shown that this isn’t a major problem so far. Finally, they express concern that too much debt financing could cause problems for them. Again, technically a potential concern, but nothing has raised this fear at the moment and the weighted average effective cost of debt being at 3.36% indicates it is not likely to be going forward.

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Next set of risks

The first of these just stresses that the liabilities on some of their properties are connected. In other words, a mortgage on property A may also contain a mortgage on property B. This is unlikely to be an issue as long as the advisory team adequately manages their debt.

The next set just talks about competition for land. As we’ve established, this is not a situation where Gladstone Land is going to be acquiring farmland and earning 25% annual returns. Farmland is pretty well scrutinized and they are likely to earn between 6-10% returns split between rent and return on land.

We’ve covered dividends before, so I’m not going into this one again. Also, failure to succeed in new markets is an issue that virtually every company faces. We’ll chalk these two up as immaterial risks.

The last issue deserves a bit more scrutiny. Essentially they are talking about the prospects of land that gets transitioned to an urban or suburban use due to land expansion. They state in the 10K that (italics added)

Although the current development market contains uncertainties, these uncertainties may be more acute over time, since we do not intend to acquire properties that are expected to be converted to urban or suburban uses in the near term. As a result, there can be no guarantee that increased development will actually occur and that we will be able to sell any of the properties that we own or acquire in the future for such conversion. Our inability to sell these properties in the future at an appreciated value for conversion to urban or suburban uses could result in a reduced return on your investment.

So, while this is a potential issue IF they were acquiring property with plans to move it from farmland to say an apartment complex, they are not acquiring properties that are expected to be impacted at the moment. Probably not a significant concern.

Yes, there are more risks. The good news is we’re almost done with the risks to the actual business…then there are one’s about the risks from using an advisor, risks associated with REIT structure, and risks about different share types. I’m going to hold off on these for a bit. You’re welcome!

Honestly, we’re going to speed through these risks as most of them are not really that surprising. The first has to do with insurance coverage. Some conditions (war, weather-related disasters, etc.) are going to create issues. Also, some insurance plans will require deductible payments, etc. Hopefully this is greatly reduced by the range of farms that Gladstone Lands is operating.

There is potential liability for environmental damages. Again, this should be greatly reduced by the advisory service, geographic diversity, and legal protection within the lease. Specifically, the 10K states

We will generally include provisions in our leases making tenants responsible for all environmental liabilities and for compliance with environmental regulations, and we will seek to require tenants to reimburse us for damages or costs for which we have been found liable. However, these provisions will not eliminate our statutory liability or preclude third-party claims against us. Even if we were to have a legal claim against a tenant to enable us to recover any amounts we are required to pay, there are no assurances that we would be able to collect any money from the tenant.

The inability of tenants to follow labor regulations is a potential issue. Again, the number of farms makes this less of an issue, but there is the possibility of minimum wage issues and illegal immigration which are higher in farming occupations than other areas.

I’m not going to get into the presence of engangered species as that seems like a minor issue and, again, limited by the geographic spread of farms. The same is true for mineral rights issues.

This leaves interest rate risk. I’m not sure, but I’m guessing just about every company has this listed in their 10K as a potential concern because (a) interest rates fluctuate and (b) interest rate fluctuations can cause problems. This is true for almost every firm that has leverage (debt) either directly or through leases. It is also true for almost every firm that relies on customers who would also be affected by leverage (debt). Is it a real risk? Sure. Is it a relevant risk tied specifically to Gladstone Land? No.

What’s this? The final set of business risks? YES!

The first of these risks is one that has already been addressed, albeit in a slightly different format. Gladstone states

These increases in the federal funds rate and any future increases due to other key economic indicators, such as the unemployment rate or inflation, may cause interest rates and borrowing costs to rise, which may negatively impact our ability to access the debt markets on favorable terms and the market value of our capital stock.

Essentially, no one knows what the future action of the Federal Reserve and other regulatory bodies will be going forward.

Cybersecurity risks are a relatively recent addition to many 10Ks, but they are relevant. Company spending on mitigating information security has increased over the years and this will likely not disappear.

We have implemented or plan on implementing additional processes, procedures, and internal controls to help prevent, detect, and mitigate cybersecurity risks and cyber intrusions, but these measures, as well as our increased awareness of the nature and extent of a risk of a cyber-incident, do not guarantee that a cyber-incident will not occur…

The last risk is definitely a newer one as in 2019, COVID was non-existant. That said, it is now which has caused many firms to recognize and respond to the risk of COVID and other public health emergencies. As a grower of produce, Gladstone Lands is going to feel the impact on shipping, shortages, etc. of any shutdowns and thus, it is likely to introduce some instability. That said, COVID (and other potential health situations) are impacting all businesses (hello, Peloton!).

Of the 37 different business risks, the three that I think are the biggest challenges for Gladstone Lands would be

• Geographic Diversity — While there is a lot of the country that has farms, current regulations restrict investments by companies like Gladstone Land (specifically, Iowa, North Dakota, South Dakota, Minnesota, Oklahoma, Wisconsin, Missouri, and Kansas) in their states. This means that while Gladstone does have 15 states that they have farms in, 84.1% of their leases (as of the 10K) were in California and Florida. Granted, there is crop diversity across these ownership structures and some geographic dispersion, it is probably less diversified than we’d like.

• Potential for Additional Growth — Farms are not exactly a “growth” business. Instead, there is a strong tendency for more yield to be produced on fewer acres of land. There are also a lot of institutions looking for opportunities. The more people looking for opportunities, the fewer you would expect to find. The reason to invest in Gladstone is partly a diversification story (farmland behaves differently than other businesses), but it is no different than tech vs. retail vs. financial. Gladstone is not creating new farms. They are owning the land and using it to create shorter-term (typically 3-10 year) leases and profiting from the rental rate plus land appreciation.

• Climate Change — One of the bigger risks for Gladstone is the potential climate change issue. As we see less water, warmer temps, less snow formation in winter, etc., this will be an issue that will require Gladstone to focus on getting the best production from the environment. Fortunately, people need to eat and farms are essential in that process. While this may require more attention, it is a risk that could represent an opportunity for Gladstone if managed correctly.

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Information Gathering — Start With the 10K

Okay, we’re going to start covering Gladstone Land Corporation. One thing you’re going to want is the firm’s most recent 10K (use the link to download), as that is where we are going to start. Note that there is a lot of extra information in the 10K, so my plan is to go through the pages and highlight things that I think are important. We’re going to start by assuming you know almost nothing about Gladstone Land.

The first thing we need to do is identify what the business does and how it plans to make money.

This is on page 6 of the 10K and provides an overview of how the company intends to make money. The ability to generate free cash flows is always important for every company as the value of the stock should be equal to the present value of all the free cash flows it is going to generate into the future. Granted, this is a moving target as those cash flows have not occurred yet. Therefore, it is really equal to the market consensus of the expected cash flows and the discount rate…neither of which we know.

However, our job is to estimate them to the best of our ability and then monitor the firm’s progress in their ability to reach them, exceed them, or not meet them.

We note that their business is to own farms (164 farms comprised of 112,542 acres across 15 states) and other farm-related resources.1 Their focus is on farms that produce annual row crops (such as strawberries) or permanent crops (such as almonds). However, they also own some commodity crops (corn/beans) and farm-related facilities (cooling, processing, etc.). They intend to continue to do this going forward (acquiring new land).

The next question is how do they intend to make money off of this land and facility ownership?

They plan to do this through a three-pronged approach:

• Distributing dividends

• Appreciation of land/facility property

• Capital gains when selling their land

Note that this is essentially a case of planning to earn money on the property (rents) and have the property increase in value over time. They want to focus on the following factors to achieve their goal.

• Owning farms/farm-related real estate for income

• Owning farms/farm-related real estate for capital appreciation

• Expanding operations geographically

• Expanding crop varieties

• Using leverage

• Owning a small percent (less than 5%) of the total assets as mortgages

Let’s take a moment here to discuss the “triple-net” lease structure. There are three basic leasing structures. A single-net lease implies that the tenant/lessee pay property tax in addition to the lease payment. A double-net lease implies that the tenant pay property tax and property insurance. The triple-net implies that the tenant is responsible for all payments including maintenance of the property. Granted, that is not their only lease format, but their primary leasing format. Essentially, it means that the tenant makes a fixed payment for the property over a set time frame and is responsible for maintenance that is not specified in the lease contract. The risk is that at the end of the time frame, Gladstone is responsible for renewing the tenant or finding a new one.

So, most of their leases are triple-net, full-recourse obligations of the tenants which means they are likely to be paid off. The average obligation for farms growing annual crops is 3-10 years, while those growing properties with permanent crops are 7-15 years. Since Gladstone is leasing the property on a triple-net basis, there is little risk of default (low-risk) which also is going to imply a lower return. The properties allow for rates to change (typically increasing) by a fixed dollar/percentage amount or they may be subject to cost-of-living adjustments. Some leases will adjust rental rates based on current market rates or include a bonus payment if the yield/price is high enough. This last type of loan is beneficial to the farmer in that it may reduce the benefit of a big year, but also reduces the risk (as the base price is usually a bit lower).

The net capitalization rate refers to the net operating income from the lease divided by the market value. This is expected to be in the 5-7% range, but may be a bit lower or higher if there is market volatility.

When looking to select land for the REIT, what types of things are they looking for?

• Water Availability — This is obviously a major concern in many areas as there are water-intensive crops in places with relatively limited amounts of water (see images of water declines at Lake Mead). Without water, farms are going to be less productive (or with too much water).

• Soil Composition — I did not realize how many types of soil make up most fields until starting to buy a couple properties with AcreTrader. It’s a lot! Soil composition must match the type of field that the crop is being grown on.

• Location — What is the phrase in real estate? Location, location, and location! Farming is going to need to be set up in the right location for both growth and harvesting.

• Price — In most business decisions, this is going to be a narrow range which makes both the lessee and leasor happy. One thing to consider is economic expansion. The closer the property is to an urban environment, the more likely the town will grow out to the property. This has potential upside, but also is going to make the property more expensive to acquire.

Granted, these same four factors are what everyone is looking for in acquiring properties. It’s not exactly like Gladstone Land found the secret formula and decided that water, soil, location, and price were going to make them rich. So, really we are trying to figure out if the Gladstone Land advisors are competent. The advantage is this is not a “Get Rich Quick” scheme. Instead it is a lower risk, lower expected return scheme that should generate, on average, low positive returns over time that match (less expenses) the returns of owning farmland.

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The above deals with the land that they are acquiring. Next, we want to look at the tenants that they seek to rent the land. Remember, the tenants do not own the land, and instead are renting it (on a multi-year basis). Therefore, the risk for Gladstone Land is are their tenants going to be able to reliably pay the rent. Also, note that not all of these are requirements.

While I’m not going to go through each item, I do want to address one that will show up again. Diversification is important in that they want to be a farming REIT that will allow investors to own not a single property or a single type of farmland, but a diversified portfolio of farmland. Things like strawberries, blueberries, wine grapes, almonds, pistachios, etc. While each market may have individual gyrations, it is unlikely that food as a whole will lose value. Thus, they want to spread out both their locations (15 different states — we’re going to come back to this in the next episode on business risks, but over 80% of lease revenues come from California and Florida) and crops to provide a bit of a cushion. It is still farmland, but not the same type of farmland.

Another key piece of their operating structure is how much debt is going to be used to finance their investments. If no debt is employed, you are simply going to earn the value of the farmland less expenses. On the other hand, effective use of leverage means that, for example, if I borrow money at 3% and invest it to earn 5%, I’m getting a “free” 2% return.

Granted, it is not truly free as it creates an obligation that must be paid by me for a variable return — I “think” I can get 5%, but I “know” I have to pay 3%. If the 5% fails to materialize, I’m going to lose money. Therefore, leverage should be used in a limited fashion2. This also allows the firm to acquire more property because they have the borrowed money plus the investors equity to invest. So, their job is to balance the potential benefits (higher returns and more property ownership) against the cost of the higher risk (debt obligations need to be paid on time).

There are also multiple limitations that Gladstone Land makes on the property it chooses to invest in.

One cautionary note is that Gladstone Land is not separated from it’s other types of businesses. Specifically, Gladstone runs four different REIT/companies as follows:

This implies that there is the potential for agency risk. David Gladstone is in charge of GLAD, GOOD, and LAND. It is important to make sure that the ownership of the company is not doing anything to enrich itself or his family.3 Depending on how comfortable you are with the various conditions on LAND’s ability to “control” the behavior of the CEO, this is going to be an essential issue to think about.

It is something that I am “okay” with. By “okay”, I mean that I would prefer it if the person in charge of Gladstone Land Corp was just running Gladstone Land without the other businesses. It is not a simple task to run multiple companies (even with overlapping lines of business). That said, it is not a deal-breaker in and of itself, but does raise an eyebrow to watch over. Reading about the implementation put into place is different than being there to see how it is implemented. This DOES make me a little nervous.

One way to check on this is to look at Yahoo!Finance’s Corporate Governance Score which js not exactly “on board” with Gladstone’s arrangement. This is an area that raises a bit of concern.

Gladstone Land Corporation’s ISS Governance QualityScore as of July 1, 2022 is 8. The pillar scores are Audit: 6; Board: 10; Shareholder Rights: 9; Compensation: 4.

Corporate governance scores courtesy of Institutional Shareholder Services (ISS). Scores indicate decile rank relative to index or region. A decile score of 1 indicates lower governance risk, while a 10 indicates higher governance risk.

As you can see high scores indicate higher governance risk (not lower). Seeing the Board given a 10 and Shareholder Rights a 9 does not inspire confidence.

This wraps up our introduction of what Gladstone Land Corporation is and how it intends to make money (what strategies are they following). It also address the agency risk inherent in the format. I like the business as a way to own farmland. It also focuses more on permanent crops than traditional corn/soybean type farms which is a plus. The diversification across geographic arenas and crop types are both benefits. Note that the goal here is not to identify the “best” land, but instead to have access to farmland as part of the portfolio (providing a little diversification to my holdings). The biggest downside is the corporate governance issues which raises the first significant red flag.

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It looks like Gladstone Land won the original competition. I’m planning on taking the next week off (and trying not to melt into a puddle as it is WAY too hot in Carl Junction at the moment). Combination of chemo week and reading the Gladstone 10K (recommended homework for those following along at home). The 10K is around 160 pages, so we might need to break it into parts.

That said, here are the results

If this is a success, we’ll hit up Howard Hughes next as it is one that I’d like to look at in more detail as well.

Peloton And Stock Compensation

One of the danger points of stock compensation is that stock prices can run quite a bit higher than one would expect…followed by a large fall from grace. A great example of this is one of our previous highlighted companies — Peloton. You can find the story of what happened on CNBC.

In one of the internal memos, Peloton told employees that eligible team members will have their post-IPO options repriced to Peloton’s closing price on July 1 of $9.13.

As an example, Peloton said options granted granted on March 1 had an exercise price of $27.62, meaning they were “underwater,” and employees were not benefitting financially until the stock passed that threshold. After the repricing, Peloton employees will be able to exercise their options after the price passes $9.13.

I guess they really wanted to drive home that the options were granted since they said it twice. 🤣 Okay, seriously though, this illustrates one of the problems with stock compensation that a lot of companies are dealing with. When the stock price drops by enough that the option is unlikely to be beneficial, what does the company do?

If Peloton were to say “Sorry, but the deal was made at $27.62 and you accepted the incentive compensation”1 then the incentive is probably a lot less relevant. You had thought that if the stock price went up you were going to benefit. However, now the stock price has fallen down to $8.48 and employees are thinking “even if the stock price triples, it is only going to be worth $25.44…I’m not seeing that bonus.” So, the incentive benefit is gone. If the purpose of incentives is to drive employees to work harder to add value, your incentive no longer is effective. This is a problem for Peloton and their ability to retain key employees. Remember that the people who leave are likely going to be the ones who are most employable elsewhere…not exactly a great business strategy.

On the other hand, let’s say that employees screw up (and this is not a knock on any Peloton employee) and destroy value, but their options are repriced, where was the incentive in the first place? Now, the stock has fallen by more than 67% and you are resetting their strike price quite a bit lower. This seems to make the incentive one where the company is in a damned if they do and damned if they don’t situation.

What is the right decision? I honestly don’t know. Stock options like this reward volatility (one of the key inputs into option pricing models is how volatile the stock is…the higher the better). They also reward value creation (increasing the value of the stock is also directly going to move the value of the option higher). If you are going to use stock options to create an incentive system for employees, how do you balance the risk of rewarding employees for creating value with the lack of incentive for stock prices getting demolished? This is going to be an issue for quite a few firms in the current marketplace and I’m glad that I’m not making the decision. My solution might be to allow them to keep the original options and grant them a lot fewer repriced options, but I haven’t really thought through the implications of that startegy.

Tweet of the Week

This was a Twitter Poll question and the options included 2 times, 4 times, or 10 times. I got the right answer (🎉🎉) without looking, but my question was how do they control for quality of house? Consider this story from the Chicago Tribune

In 1900, for instance, a typical American new home contained 700 to 1,200 square feet of living space, including two or three bedrooms and one or (just about as likely) no bathrooms. It was probably a two-story floor plan.

At the turn of the 20th Century, more than 20 percent of the U.S. population lived in crowded units, with entire families often sharing one or two rooms. Most homes were small, rural farmhouses and lacked many basic amenities, complete plumbing and central heating chief among them.

Then, follow that up with the update from more modern times

The average single family house in the United States has overall increased in size since 2000. It reached its peak of 2,467 square feet in 2015 before falling to 2,261 square feet by 2020.

I’m guessing that the wifi routers used in 1900 might (just maybe) be a little less powerful than the ones in 2020 (narrator — there were no wifi routers in 1900). Heck, the houses in 1900 lacked “many basic amenities” such as “plumbing” and “central heating” to name a few.

In 1900, there were only 45 states in the US (Oklahoma entered in 1907, New Mexico in 1912, Arizona in 1912, Alaska in 1959 and Hawaii in 1959). For the record, in 1888, the US had only 38 states. Black American home ownership has it’s own set of problem as this CNBC article illustrates. Then location changes, both across the country and within cities also played a big part.

What this means is comparing home prices from 1900 to 2020 is probably a pretty big stretch even for those that specialize in trying to hold the data constant. This data was based on the Case-Shiller Home Price Indices and you can see the methodology paper here that explains the process. One interesting note is that the index was formed in 1987 and uses a “repeat sales method” of including houses. Unfortunately, this is going to create a bit of a bias as it is not including every house. Consider this comment from “Repeat Sales House Price Index Methodology”

A third measure is how well the index represents trends in the overall market. Previous research has shown that repeat sales homes are fundamentally different from single sales; in light of this work, it is difficult to argue that traditional repeat sales indices can truly represent the housing market. While all of the indices (including the median index) exclude houses that do not sell, the median and autoregressive index do include single sales which can make up a large proportion of total sales. Therefore, in this regard, these two indices are more representative of the housing market.

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Separating Quality Improvements from Quantity is Not Easy

The main point of this ties back into my belief that the world is getting better at a very fast rate, but we as a species tend to focus on the “what could/is going wrong” rather than the “what could/is going right” side of the equation. This makes perfect sense as our day-to-day existence is based on preventing bad things from happening and keeping up with the 1001 different tasks at hand. We rarely have time to stop and appreciate all the huge positives that have impacted our lives over the last 10-150 years. Things like (and this is just a VERY small random sample)

• Apple releasing the iPhone in 2007

• Traveling to space in 1969 to land on the moon (I was just about to turn 1)

• Bloodletting was finally stopped in the early 20th century (apparently still included in the text in the 1923 edition of The Principles and Practice of Medicine)

• Life expectancy increased from from 32.5 years for Black men in 1900 to 68.7 years in 2000. White men were expected to live for 46.6 years in 1900 and 74.7 in 2000. Those numbers are currently up to 76.61 for men and 81.65 for women in the US.

• Flat screen TVs, internet access, medical advances, technological advances, etc.

All of these things have made the world a much better place. It’s just that we don’t spend much time thinking about them. Instead, we fret about things that are both significant and insignificant in our lives. Things like how are we going to afford the latest medication, how expensive gasoline is, etc. These things matter far more to our day-to-day lives and seem more important. I’ve done the same thing myself many times. I get it. Just remember to take a moment to look at the big picture because we are doing quite well when you look at decades instead of just the current week.

Think of housing and look at the numbers from 1910 to 2015

US-wide, homes built in the last 6 years are 74% larger than those built in the 1910s, an increase of a little over 1,000 square feet. The average new home in America, be it condo or house, now spreads over 2,430 square feet. It is also important to note that, parallel to the rise in living space, households have been getting smaller over the same period. In 2015, the average number of people in a household is 2.58, compared to 4.54 in 1910.

Then, think about plumbing, air conditioning, and all the other modern amenities available now vs. in 1910. Housing costs have gone up not just because housing is more expensive, but it is also a LOT, LOT nicer now.

If we think about economic numbers (the macro story), you quickly realize that just like in finance, no one number is magic. Inflation came in this month at a 9.1% increase. However, that tells us what happened in the past. We want to know what is going to happen going forward. Granted, inflation doesn’t just jump up to 9.1% this month and fall to -1.5% next month…there is definitely a high correlation between one month and the next. It IS information, but it is a very small piece of a very large puzzle.

It was higher than expected (it came in up 1.3% vs. the 1.1% that was expected). Notice that the difference there is incredibly small, 0.2%. Assuming you spend $5000 a month, your budget went up by $65 instead of by $50. Granted, $15 isn’t nothing and not everyone is spending $5000 a month, however that is for the person that buys the products in the CPI basket in the same proportion as the basket (which is essentially no one).

This is not to say inflation is not a problem as it clearly is. Instead it is saying that a big part of the problem is not just what is happening but how we feel about what is happening. Is inflation making me rethink a purchase that I was planning to make? How are we (as a society) responding to the increase in prices? How long is inflation going to be higher than normal? Another month or two or another year or two? These will play a part as well. As I said…economics is not easy!

Taking the time and effort to focus on how life has improved is not easy. It’s much simpler to think of day-to-day changes. That said, it is something we all need to take some time to do. The question of whether or not you’d rather be alive in 1922 or 2022 should be one of the easiest questions to answer for the majority of people.2 100 years is a relatively short time period, but the difference is incredible in quality of life.

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Even if you are not in the mood for this week’s substack, be sure to check the last item which is going to lead to the next several weeks’ activity. No promises for an updated publication each week as we’ll see how the experiment progresses.

Luck vs. Skill

Let’s start with a slide show that I used when teaching Investments class. One of the investment gurus from our recent past is Bill Miller. He crushed the S&P 500 for fifteen straight years. Not five years. Not 10 years. Fifteen straight years after fees (so net investor returns) he beat the S&P 500. That seems pretty damn impressive!

Some years were really close (such as his 7 basis point beat in 1994) while others were runaways (like his 1946 basis point crushing in 1998). However, if someone outperforms the S&P 500 for 15 years in a row, it has to be more than luck.

Or does it?

Here are the next 5 years of Legg Mason’s Value Trust Fund.

So, he crushes the S&P 500 for 15 years in a row…then gets crushed for four of the next five years. So, for the full period he slightly outperformed the market. Although, if you jump back to our column on returns and did a dollar-weighted return, you’d probably find out that he underperformed the market because his worst years were at the end when you’ve accumulated most of your income.

However, one of the key aspects of finance is that expected return is related to risk. All else equal, the greater the riskiness, the greater the expected return.1 This leads us to ask about how risky the returns were for LMVT. Again, the story becomes a little less impressive.

If we look, not only did LMVT earn a slightly higher geometric return, but it accomplished it by taking on quite a bit more risk. Overall, there is a significant chance that this is far more of a luck aspect than it is a result of skill. Granted, Bill Miller recognizes this.

As for the so-called streak, that's an accident of the calendar. If the year ended on different months it wouldn't be there and at some point the mathematics will hit us. We've been lucky. Well, maybe it's not 100% luck—maybe 95% luck.

Differentiating Between Luck and Skill

How do we separate luck vs. skill? Probably the easiest way to think about this is with standard deviation. If you think of two distributions you can see how much is luck vs. skill. Here are three possible scenarios2

The first example would be a two-player contest with the first team being a little less talented than the second team. Let’s say it is New Orleans Pelicans vs. Golden State Warriors. Golden State is going to win most of these games, but the Pelicans are going to occasionally win a few. It could be injury issues, one player shoots better than normal, lackadaisical play, or any of a number of issues. The second example would be a two-player contest with the first team being Boston Celtics and the second team being Golden State Warriors. These two teams are more evenly matched, but Golden State was better (assuming this year’s victory was not purely luck) and won the NBA Championship in 2022. There were some injury issues, Boston had far more turnovers, etc. The last scenario would be the Houston Rockets vs. Golden State Warriors. Golden State is a superior team, but there is still a chance for an upset…just a much smaller chance.

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Michael Mauboussin looked at some types of competition and came up with the following diagram

If you think about this, it makes a lot of sense (although Ed Thorp may have a little different take on roulette thanks to his wearable computer…if you’re not familiar with the story, it’s worth a read). Slot machines and roulette should have a negative sum experience. In roulette, the “house” has two numbers (0 and 00) along with 36 other numbers. The house edge comes from the fact that you have a 1:38 chance of getting the number right (because of the two house numbers), but the you get paid as if there are 36 numbers. This gives the house a small edge (2 of 38 or 5.26%). Slot machines also typically pay out about 85-95% of their take.

We know that markets are pretty efficient and it is VERY, VERY hard to outperform on a risk-adjusted basis. Consider that over a 10-15 year time frame, mutual fund performance is not very encouraging. Keep in mind that these are professional investors who have the time to keep up with everything going on in markets. In other words, they are working 40+ (and keep an eye on the plus sign) hours a week to make sure that they have the edge.

Notice that the performance numbers all drop as the years go up until they are between 12.8% - 18.6% once we hit 15 years. This makes sense as funds have expenses, trading costs, etc. Indices do not. Even if you invest in index funds, you are likely to underperform the index by a small amount (although if a fund underperforms by 0.75% vs. 0.10%, you’ll feel a lot happier in the 0.10% underperformance version).

That said, there are two arguments for why individual investors may outperform. One, they are reducing costs (well, assuming they enjoy the challenge of trying to outperform which may make their time cost negative). Two, they have a broader pool of potential investments (note that small and mid-cap did better than large-cap and all US equity). By choosing to focus on small-cap and mid-cap stocks, where they can focus on firms with little analyst coverage (especially in the arena of under $2B dollars of market capitalization), there is more potential to find success (maybe). The flip side is that overtrading, poor tax planning, ignoring trading costs, unrealistic recognition of expected returns, etc. far exceed the potential benefits for the vast majority of investors.

When you get out to chess, there are chess ratings which range from 100 - 3000. If someone with a score of 2200 played someone with a score of 1000, the 2200 player would win every time (barring having a heart attack in the middle of a game, an internet disconnect, or divine intervention). There is little luck in chess.

Skill in Investing

So, how much “skill” do you bring to your investing game? Do you spend time reading and understanding the advantages/disadvantages of your investments? Can you explain why a firm has a higher expected return or a higher standard deviation? Can you explain why two investments are higher or lower correlated to each other? Do you spend time thinking about “what can go wrong?” Do you understand what moats are and how well they can be defended? Do you think about technology and how it is going to change (and how that change will alter the competitive dynamics of your companies)? Do you have a model for FCF forecasts out five years that is not based on a random number generator like ARKK funds? Research (developing the necessary skill) takes a LOT of time and effort.

Unfortunately, it is not something where the effort is merely starting up. You have to kick a lot of rocks (which often results in stubbed toes) in order to uncover potential opportunities. Then you have to continually monitor those opportunities. Once you get a portfolio that is reasonably well diversified (say 15-20 carefully selected stocks), it is going to take a lot of time to keep up with them. It is a hard game to play and the results are that you are most likely going to slightly underperform the markets.

Going Forward

One of the things we are going to do going forward is a valuation exercise. If you are reading, let me give you a few names to choose from.

Note that Chipotle has been done (but this was about 2 years ag right as COVID was hitting). You can see the YouTube videos here. Howard Hughes Corporation is a land ownership company (develops Master Planned Communities including residential and commercial properties). Gladstone Land is a farming REIT that focuses less on row farms and more on fruits (strawberries, apples, blueberries, etc.), almonds, and pistachios. Innovative Industrial Properties is primarily a cannabis REIT where the focus is on ownership of acquisition, ownership and management of specialized properties. Finally, McDonalds operates and franchises McDonald's restaurants in the United States and internationally.

The key is that these are relatively small companies (Chipotle and McDonald’s are bigger at $37 billion and $187 billion, but are still narrowly focused firms). The others are much smaller between $350 million and $3.5 billion and again have narrow focuses. The best place to start is from a small base. Also, I do reserve the right to go to the second (or third) choice if the first one proves too challenging to do well.

This will be a multi-part process and may take 4-7 weeks of publishing to get through what I am able to cover. There will also be large pieces missing (I’ve done this before, but only for teaching and personal activity…expect some errors to be made). Feel free to comment if there is something you don’t understand. It may very well be an error on my part or explaining it better will help us both.

Just remember, the price (free) guarantees that you won’t overpay unless you find it a waste of time. Then…check back after the series is done.

Two stories to start the day. The first is a sad continuation of US gun culture. Again, this is not a critique of guns in general, but instead of irresponsible gun owners. If you do own a gun, please take some time to recognize that being responsible and respectful of the weapon you possess is an essential part of ownership. There are a lot of good reasons to own a gun (while I don’t, I understand the reasons). So please, lead by example. Whether you enjoy shooting for the craft, to hunt, or self-defense, take the time to recognize the power of what you own and treat it as such. Please.

The second story provides a great counter example to the first. Keanu Reeves is exactly the person we need to uplift our spirits. While finding “feel good” stories about Keanu seems pretty easy, there was a story this weekend about him interacting with kid who was asking questions. How did he handle it? By answering the questions and then, importantly, asking the kid a few more questions.

So, thank you to Keanu for taking the time to interact with people who reach out.

More importantly, thank you to the TON of you out there doing your part to make the world a better place. The gun story is going to get a lot more press, but the story of everyone out there doing their part to make the world better is going to get overlooked…and it shouldn’t. Thank you!

Polling Update

Just for those that are curious, the polling did seem to work. There weren’t many responses (12 overall) and here are the results:

Kudos to the two of you that went with the first answer! Now I need to think about some useful ways to incorporate it.

Two Quotes That Deserve Some Attention

The first quote is here

The second quote is here

Interestingly, both quotes appeared within about 30 minutes of each other, but both tied to an interesting theme. One that I’m going to follow-up on in a bit with a question from LibertyRPF’s substack. However, before that, let me address both of these. If you’ve been reading my column for awhile, you probably have figured out that I’m not offering up any “new” information.1 Instead, I’m repeating information that I have learned over the years. In other words, I’m far more of an aggregator than a developer.

What exactly does an aggregator do? Well, according to this page, we produce 2.5 QUINTILLION bytes of data every day. This site suggests that there are “more than 600 million blogs on the internet, with over 7.5 million blog posts published per day in 2022.” 7.5 MILLION PUBLISHED PER DAY!!! I don’t know about you, but I probably would find it hard to read 7.5 million blog posts each day.

Therefore, we need people (aka aggregrators) to figure out what things may be relevant and discuss it. In addition, they hopefully will be adding some insights to help make that knowledge part of your toolkit going forward. If they do this, while managing to keep you entertained (you have to be able to tell a story well), they will gain some traction and continue. If not, they will either keep writing (because they enjoy it) or lose interest and disappear.

In other words, look for more types of information that you can find in other sources. The advantage I have is time, which allows me to focus on what I think is relevant and pass it along. Hopefully, I can spin a little better story than the average textbook author (a nice low bar) and provide some level of information (mostly) with a few bad attempts at humor.

LibertyRPF Asks a Question

One of the sites that I read regularly is Liberty’s Highlights. On Monday, he asked three questions which I thought were interesting and would be worthwhile to address here. First, the questions:

So, let me attempt my answers below.

What I do best is teaching. More specifically impart complex topics in a relatively simple format. Sometimes this is relatively easy like introducing a financial ratio such Return on Invested Capital = NOPAT/Investing Capital. If ROIC is greater than your Weighted Average Cost of Capital, this is good. If not…not so much.

It sounds simple (and it is), until you get into the important part. As an investor, your goal is not to tell me what ROIC has been, but to project what it is going to be going forward. Also, you need to do the same with the firm’s WACC.

Unfortunately, this means you need to check your magic 8 ball because what happened to the firm over the past few years does not tell us what IS going to happen to the firm over the next few years. Also, if your ROIC is 13% and your WACC is 7%, that is good. What about if it is 15% and the WACC is 7%. That’s better, right? Okay, so how much “value” does it add? Is it 15% and heading down while the 13% is heading up? Being able to calculate the ROIC is relatively easy, but not meaningful.

Being able to interpret your calculation is far more meaningful, but now you need to explain they “why” behind your reasoning. This is the hard part because, unfortunately, there is not a “correct” answer. Instead it is a question of how you build your case and what story you are trying to tell.

Consider the example mentioned by Vince Martin of Overlooked Alpha

Since 1948, Real GDP has grown over 10% in one single year (10.56% in 1951) and now it is going to grow by 30-50%? Granted, she didn’t say REAL GDP, so maybe she was referring to nominal GDP (in which case it has grown by more than 10.56%, but mainly in inflationary times…maybe she is predicting that inflation will grow between 20-40% and real growth will be 10%).2 Technically, it is possible, just highly improbable.

So, take the time to think about what story you are trying to tell and whether or not it makes sense.

That said, the key to teaching is

• Explain the concept and work through an example

• Explain the flaws of the concept

• Explain how to use the concept as part of your overall analysis

• Answer questions

This is true for something as simple as a financial ratio or as complex as a delta-neutral hedging position. Too many teachers explain the concepts and work through an example, and typically stop there. This is a half-assed way to teach. If you aren’t going through the rest, such as “what can go wrong on a delta-neutral hedging position” and how would you apply the concept in a real world scenario, you aren’t really teaching the concept.

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How good am I at teaching? I’m going to cheat and not answer that question. I’m good at it, but the main reason is because I am far more interested in steps 2-4 rather than step 1. Do I get all the flaws? Probably not…I’m sure there are more out there beyond what I see (or may be too technical for the course). However, I spend time to address most of them (especially as I moved to higher level courses such as Investments I/II compared to Business Finance) that I saw and talked about how to apply the concept. I enjoyed answering questions (although less the “is this going to be on the test” and more of the “how do you see X impacting Y”) that involved thinking.

If I had to get better at it, how would I accomplish that? This is a hard one because I don’t really have an answer. Some of you were my former students and I’m always up for suggestions. Teaching is a big part of why I write this substack and make occassional YouTube videos, but that is more of a part-time hobby.

The biggest thing though (which I started doing more over the past 5-10 years of teaching) is bringing in other topics. I like to think of this as the David Epstein “Range” type of approach.

When I taught an MBA class, I’d incorporate Freakonomics, TED Talks, etc. on leadership, compensation, ethics, etc. where students would read the article (or listen to the podcast) and then write about it in an interactive online forum. That was a start as it forced students to read something outside the textbook, but gave them flexibility in what they were reading.

Over the last two years that I taught, I would buy students a copy of Range and had them read and post about it (ten posts were expected). It had nothing really to do with “finance” (although the kind vs. wicked learning environments tied in REALLY well to finance), but the idea of sampling careers, analogies, etc. were (hopefully) very productive to students wanting to become MBAs. A big part of that is that someone pursuing an MBA is likely going to end up in a leadership position (regardless of the specific field they go into). Therefore, they need to understand what leads to better decisions.

We still did valuation, cost of capital, time value of money, etc., but I wanted to expand the course to get them to think about how things relate to each other. More of this would be good.

What is preventing me from putting that plan into practice right now? Retirement!

Here’s the problem. I’m going to be 54 in under 2 months. That is still too young to be retired, but honestly I see it as giving me 15-20 years of “active” life left (times where I can do things without worrying about whether the wheels are going to fall off). Granted, there is a margin of error there as you can always get hit by a bus or hit 75 and still be active. That said, the average 65-75 year old is not looking too spry. Years take their toll whether we want them to or not. One of my favorite quotes (the attribution is questionable) belongs to Mark Twain (as do seemingly half the quotes out there). It goes like this (along with my follow-up):

"Twenty years from now you will be more disappointed by the things that you didn't do than by the ones you did do. So throw off the bowlines. Sail away from the safe harbor. Catch the trade winds in your sails. Explore. Dream. Discover." -- (allegedly) Mark Twain

"Twenty years goes by quicker than you'd think." -- Me

I like to run. There are trails that I want to get out and explore through hiking/backpacking. The US has a lot of things that I want to see (sorry, not an international traveler). So far, I’m able to run, but there is a limited amount of time to do everything we want.

Morgan Housel sums it up greatly with this quote

These definitions are my own, but here’s the distinction: Rich means you have cash to buy stuff. Wealth means you have unspent savings and investments that provide some level of intangible and lasting pleasure – independence, autonomy, controlling your time, and doing what you want to do, when you want to do it, with whom you want to do it with, for as long as you want to do it for.

I’m at the stage were my wealth is enough that I can do what I want (which is not to say we’re rich…we still are pretty careful on the spending front).

Other people are wired differently. LeBron James (and more power to him) has far more riches than he could spend, but still appears in commercials selling crypto and Hummers. However, the difference is that he is doing what gives HIM "some level of intangible and lasting pleasure”. This is great as we need people like that.

Unfortunately (or I should say "Fortunately”), I’d prefer to relax, read, go backpacking, travel to see Redwood National Park, the fall leaves in Minnesota, etc. Therefore, let retirement continue!

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Time for a Poll

Apparently Substack decided to add polls, so I’m including one just for fun. While you can skip it, I just want to see how it works for future use. I think you have to pick the main reason (no double-dips), so give it a shot. It should be good for 3 days from publication.

Also, I want say “Thank You” to Steven Anderson for the questions that inspired today’s post. They are not complex, but a good refresher never hurts (especially if you are like about 100% of the students who were not always paying attention in Investments class…totally unlike me as a student 🤣). If anyone has questions — about anything, please feel free to ask…seriously, I can always use some topics to discuss!

Arithmetic vs. Geometric Returns vs. Dollar-Weighted Returns

When is a 10% return not a 10% return? The answer depends on how you are calculating returns. Today, we’re going to introduce three different returns and talk a bit about them.

Arithmetic Return

Let’s start with a series of three sets of returns as follows (slightly exaggerated to drive home the key information):

The arithmetic return is both the easiest (and the least useful) of returns as it ignores any compounding impacts. The formula for arithmetic return looks like this

So, to get the arithmetic return for the first set of returns, I would just add them up and divide by the number of returns (5 in this example). Therefore, add them up (-3% + 8% + 4% + 10% + 7%) = 26% then divide by 5 and we get 5.20%. Unfortunately, this misses the compounding impact, which we see when we jump to the second return stream. When I add up these returns (-40% - 50% + 70% + 50% + 20%), I get 50%. Divide this by 5 and I have an average return of 10%. AWESOME!!

Unfortunately, I didn’t actually earn a 10% return…I lost money. How do you lose money while “earning” a 10% rate of return? Because of the compounding impact. When I lose 40% in year 1, I do not get back to even with a 40% return in year 2. I’m actually still down by 16%. Instead, I need a 66.7% return to get back to even. If I start with $100 and earn a -40% return, I am down to $60. I need to get it back to $100, which means I need a $40 return (to recover my loss), but I only have $60 in capital. $40/$60 is a return of 66.7%.

Geometric Returns

This means that I need to take into account the compounding effect of returns to figure out what my return really is. The geometric return formula looks like this:

As you can see, the math is getting more complicated. However, it is also more accurate. Now, I can see that in scenario #1 my geometric return is really close to the arithmetic return. [(1 + -3%)(1 + 8%)(1 + 4%)(1 + 10%)(1 + 7%)]^(1/5) - 1 = [1.28235]^(1/5) - 1 = 1.0510 - 1 = 5.10%. However, the return from scenario #2 is quite a bit different. Here, I get [(1 + -40%)(1 + -50%)(1 + 70%)(1 + 50%)(1 + 20%)]^(1/5) - 1 = [0.918]^(1/5) - 1 = 0.9830 - 1 = -1.70%. This IS quite a bit different than my 10% arithmetic average.

Problems with Arithmetic Returns

The biggest problem with arithmetic returns is the lack of compounding. If we look at the return scenario #1, we can see that it is a low-variance (the numbers don’t change much from one period to the next) sequence. In this case, the arithmetic numbers will slightly overstate your return, but not by much (as in 5.20% vs 5.10%).

However, when you have volatile returns, the difference can be signficant. If I take a stock like SNOW (Snowflake) which closed at $401.89 on November 16, 2021 and fell to $113.30 on June 13th, 2022, you had a return of -71.8%. If the stock increases by 71.8%, you are now at $194.66…and still down 50%!1 The more volatile the stock returns, the greater the error you are going to receive using arithmetic returns. Geometric returns take a little more work, but are far better for looking at historical data.2

Dollar-Weighted Returns

Unfortunately, for most of us, neither arithmetic or geometric returns are ideal. The reason for this is that we don’t invest that way. Instead, we put money into stocks over time. If you start investing at age 25, you have 35 years until you’re 60. So, let’s assume you plan to invest a total of 9% of your income over the next 35 years. You currently make $60,000/year and are going to see your income rise by 3% each year. How do you figure your rate of return? The answer is dollar-weighted returns.

This is the trickiest one because you can only solve up to the current year.3 Let’s look at scenario #2 and scenario #3 in the examples above and assume that you are putting in $5000 at the start of each year.

Let’s go throught these two examples, starting with scenario #2. In our first year, we contribute $5000 and it loses 40%, which is going to leave us with $3000. Then we add year two’s $5000 to give us $8000 and lose another 50% (not a great start) to give us $4000. Finally, we get a decent year in year three with a 70% return. So we start year 3 with $9000, get the 70% return and we are up to $15,300. Year 4, we add our next $5000 and supplement it with a 50% return to bring us up to $30,450. Finally, in year 5, we add our last $5000 and get a 20% return to give us $42,540.

Now we know that we have put in -$5000 per year (our PMT) for 5 years (N) and ended up with $42,540 (FV). Because we put our payments in at the beginning of each period, we need to set the calculator to BEG (for beginning of year payments) and solve for our I/Y. Note that we do not have a PV, so we are going to enter a zero. It will look like this:

SHIFT BEG 5 N -5,000 PMT 0 PV 42,540 FV ==> Solve for I/Y and get 18.28%

Repeat this for scenario #3 and you will end up losing 19.78% per year

SHIFT BEG 5 N -5,000 PMT 0 PV 13,450 FV ==> Solve for I/Y and get -19.78%

Why are the results so different? If we look at arithmetic returns and geometric returns, we end up with the same values (10% arithmetic and -1.70% geometric). However, this ignores the fact that our money invested is growing over time as we put in a new $5000 every year. In scenario #2, we get in our “bad” years early on before we have much money to be impacted. However, in scenario #3, we have our “good” years early on and the “bad” years at the end. Timing of returns matters a LOT in your outcome. This is why something like honestmath.com is so essential. It allows for randomness in returns (we don’t know what the future holds) to impact our outcomes under a simulation.

The point is that when you are putting money away, you want your bad years early on (returns are not constant…8% expected return does not mean you are going to earn 8% every year). Then, once you retire, you want your bad returns to occur later on. If only life cared what we want. Timing randomness is not predictable (strange but true fact 🤣🤣), but it is in your interest to be aware of it, so you can adjust your savings/spending habits if returns do not move in your favor.

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Price-Weighted vs. Value-Weighted Indices

The other question had to do with indices. The two biggest indices are the Dow Jones Industrial Average and the S&P 500. If you’re reading this, I’m sure you are familiar with both of them. The first point is that they are very differently constructed, but behave similarly.

Dow Jones Industrial Average

Let’s start with the Dow Jones Industrial Average. It was created way back in May 26th, 1896.4 The original companies were

• American Cotton Oil Company

• American Sugar Refining Company

• American Tobacco Company

• Chicago Gas Company

• Distilling & Cattle Feeding Company

• General Electric

• Laclede Gas Company

• National Lead Company

• North American Company

• Tennessee Coal, Iron and Railroad Company

• United States Leather Company

• United States Rubber Company

I think we have one of those twelve companies still in existance (kudus to GE). One of the keys to the DJIA that make it unique (remember…1896 was a bit before Excel) is that it needed a simple way to calculate the average. What is simple? How about adding up the prices and dividing by twelve.5 This is what is known as a price-weighted index. We’ll get back to why this is a potential problem later.

Over the years, there have been several changes in the Dow as companies were acquired, became too small, or for strategic reasons.6 The most recent changes were replacing Exxonmobil, Pfizer, and Raytheon with Salesforce.com, Amgen, and Honeywell on August 31, 2020. As a side note, the three stocks that were dropped have had returns of 142%, 53%, and 61%. The three replacements have had returns of -32%, 2%, and 12%. Small sample size and all, but as you can see the ability to improve the index by picking the “best” stocks doesn’t work out near as well as you might expect (repeat after me…markets are pretty damn efficient!). The current list of Dow Jones Industrial Average stocks can be found here.

Let’s go back to the price-weighted concept because it is important. Let’s consider Apple, which was added to the Dow in 2015 (not long after a 7 for 1 split in 2014). It continued to perform well and climbed to $499.24 on August 28, 2020 before it’s 4-for-1 split over the weekend, dropping the price to $124.81. This caused Apple’s influence on the Dow to drop from about 12% to 3%. Note that the value of Apple’s stock did not change, just the price changed. So a 10% upward movement in Apple (assuming the other stocks remained unchanged) would lead to a 1.2% movement in the Dow on August 28th, 2020 (compared to a 0.3% movement in the Dow on August 31st, 2020).

As you can see, there is no reason for Apple to have 4 times the impact on one day than the next other than the stock split (which shouldn’t impact value at all as it merely splits 1 share into 4 shares). As of Friday June 24th close, United Healthcare traded for $495.64 and Intel traded for $38.61 which means that United Healthcare could rise by 1% ($4.96) and Intel fall by 10%( -$3.86) and the DJIA would be up for the day.

Another problem with the price-weighted index is that it only represents 30 companies out of around 4000 in 2020 (no, I didn’t actually count them). So, we are accounting for less than 1% of all the stocks, which hardly represents a diversified portfolio. Then again, maybe it does. If I look at the DJIA, it includes Apple, Microsoft, Johnson and Johnson, United Healthcare and Visa (5 of the top 10 largest companies according to this site). These 5 companies account for $5.67 trillion (out of a total of $41.75 trillion) or 13.58%. Add in the rest of the DJIA and you are covering a reasonable size of the market. We’ll see that the same holds for the S&P 500, but the numbers are even more top-heavy as all of the top-ten are included. So, it is not 100% diversified, but does a reasonable job.

S&P 500

The S&P 500 is a value-weighted index of 500 companies. It has been publicly traded since Monday, March 4, 1957. Interestingly there are 505 stocks due to some companies having more than one type of stocks — such as GOOG and GOOGL — which bother represent Alphabet (go figure that one out). You can see the list of stocks here. I’m not going to go through recent changes, since it changes multiple times throughout the year (about 17 times as often as the Dow).

The S&P 500 has two significant advantages over the DJIA. First, it has 500 companies rather than 30. While this still is only a fraction of the 4000 publicly traded companies (give or take), it represents a significant portion of the market capitalization. The second distinction is that in order to calculate the value of the index, you divide the total market capitalization by a divisor (which changes on a constant basis due to share issuances, capital structure issues, and other changes).

While you would think that having 500 stocks would provide a better measure of diversification than 30 (and you would be right to a very small extent), it is not as big of a difference as you might think. Here is a correlation of the DJIA and the S&P 500 over the past 5 years based on weekly returns — 0.97. As you can see, it is VERY close to 1.0 (which is the maximum). The reason is that (a) market forces are a big driver and, more importantly, (b) they both represent large-cap stocks which are going to tend to move together. While more institutions may look at the S&P 500 (or many other individual indices), the actual index is not going to make a big difference in your return. This is because the 10 largest companies are all part of the S&P 500. They represent 24.4% of the total market capitalization of the US market. This is also true (although to a lesser extent) for large-cap vs small-cap indices as the S&P 500 and Russell 2000 (large-cap vs. small-cap indices have a correlation of 0.88 over the past five years on weekly data).

The other factor is the market capitalization weighted stock returns. Apple is going to be a bigger proportion of most people’s portfolio than PlayAGS (AGS). C’mon, everyone knows about PlayAGS (which I discovered by randomly picking a stock in the Russell 2000), right?

That is because Apple represents over $2.29 trillion in market capitalization while PlayAGS represents $213 million. In other words, Apple’s market capitalization is 10,000 times that of PlayAGS (actually a little more). Therefore, a 1% move in Apple is going to add about 10,000 times the overall capital to the market as a move in PlayAGS and SHOULD be weighted more heavily in an index trying to tell us what the market is doing.

Also, because stock splits don’t change market capitalizations, a four-for-one stock split in Apple will not influence the denominator in the index. We do have to make an adjustment in a price-weighted index, but not in a value-weighted index. Thus, stock splits are no longer essential. We do still need to adjust for stock substitutions.

Problems with Indices

Remember that indices tell us what markets HAVE done. I can look at the S&P 500 and tell you that since 1970, the S&P 500 has lost value (including dividends) in 10 years (out of 52). It’s 25-year average return through 2021 has been 9.76%. These tell me what markets HAVE done. What you want to know is what they WILL do (unfortunately “have” and “will” are two very different factors). We can assume a 10% return if we are following history. Personally, I’d go with 8% returns going forward just because I tend to be skeptical, but that is about as handy as asking your magic 8-ball. Just remember, there is no need to hedge against the zombie/nuclear apocolypse. I doubt your financial future will be that important in such a world, so I think we can safely ignore -100% returns. Instead, you might want to hedge a bit by investing in a few different asset classes. These include bonds, real estate, gold, farmland, cash or even Bitcoin.7 While stocks will always represent my biggest asset class, it does make sense to include a few other alternatives.

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Chemo week starts on Monday and since I was an idiot who decided to write about Uvalde two weeks ago, I’m going to take next week off. Enjoy your downtime where I’m sure you’ll find plenty of other stuff to keep you busy.

Finance? What’s This?

We’ve gone a bit off the rails (which is a good thing) over the last few weeks as we’ve talked about college and Uvalde. I said from the beginning that we would cover a range of topics since this is as much my retirement hobby as anything else. So expect to be sidetracked some more in upcoming weeks, but for now we’re going to return to finance.

Today’s topic is diversification vs. diworsification — can we have too many assets? My quick answer (which applies to all of us without the investing bug) is no. Why, because ideally you will be well diversified across stocks, fixed income, real estate, international, and maybe a little gold (I don’t own any) in ETFs. You’ll adjust for risk tolerance about once a year, take advantage of tax-sheltered savings plans, and save regularly. In 30-35 years, you’ll ride off into the retirement sunset and never spend more than an hour or so a year on your investment decisions. This will leave you plenty of time to pursue reading, going for a walk, gardening (too many bugs and weeds for me), playing with your kids, or any of the other hobbies that are more fun to most people.

For people who were dropped on their heads as small children, you might find investing interesting (and yep, I’m in this club). If so, let’s see if we can find a small edge (which evidence suggests is less likely than we’d like to believe) which actually would make it worth doing.

Academic Time

Feel free to skip this section if you’ve already got a good grasp on it. It is not reinventing the wheel, merely pulling up expected return, standard deviation, correlation and bringing us up to speed on the what we mean by diversification. I’ve covered this a bit before, but we’ve got some new readers since then.

Expected Return

The expected return is merely the average return we are going to earn over a specific holding period. While it is typically introduced as a probability distribution, that is a poor way to look at it because it assumes we know (a) the probability of each event and (b) the outcome of that event. The reality is that we don’t know either one. That said, let’s go through a quick example.

In this example, the expected return is 9.0% and the standard deviation is 18.28%.1

Then we move onto the expected return and standard deviation of a portfolio which gets a little more complicated for the standard deviation. This is because we need to assume that our assets may be correlated.

Correlation

What do we mean by correlated? Correlation refers to the rate of linear relationship (we’ll come back to this) between one variable and the other. So, if we are looking at two stocks (let’s call them A and B) and every time stock A is up, B is typically up as well, we have positive correlation. If every time stock A is up, B usually moves in the opposite direction, we have negative correlation. Finally, if every time A is up, B may be down or may be up (there is no relationship), we have 0 correlation. Correlations can not exceed 1.0 (perfect positive correlation) or fall below -1.0 (perfect negative correlation), but rarely will you ever see a correlation of 1.0 or -1.0. Even if you take a look at companies in the same industry (such as oil and gas), the correlations between BP and Exxon (on weekly data over the past 5 years) is 0.77. Here you can see some correlations through 2020.

Correlations And St Deviations 2021 Edit2

151KB ∙ XLSX file

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Note that most correlations are weakly positive (due primarily to general economic factors like inflation, GDP growth, tax rates, etc.) but lowered dramatically by firm-specific factors (factors impacting Amazon are likely very different than those impacting Exxon). Therefore, the average correlation is probably going to be in the 0.20 - 0.35 ballpark. If you look at the “Handout” sheet in cells B60 and B61, you’ll see the average correlation across all securities (0.29) and the average correlation for firms in the same industry (such as BP and Exxon at 0.52).

Expected Return and Standard Deviation of a Portfolio

When looking at a two-stock portfolio, we get the following formulas.

If we have Stock A with a 9% expected return and 25% standard deviation and add Stock B with a 9% expected return and 25% standard deviation in a 50/50 mix, the portfolio standard deviation will be BELOW 25% — with no reduction in the expected return. This is the free lunch of diversification. For example, assume the stocks have a correlation of 0.3. Then, the expected return will be 9% and the standard deviation will only be 20.16%.2 As mentioned earlier, it is really stupid to only own two assets as many people hold portfolios of assets. Therefore, you can expand the standard deviation of the portfolio formula like this (where Cov stands for Covariance)

Ultimately, this will give you a standard deviation mix that looks like this (with a large group of assets to create random 1-asset, 2-asset, 3-asset, 4-asset, etc. portfolios).

So, the standard story on diversification is that if we combine assets (the graph refers to stocks, but better to think of assets) in a portfolio, we greatly reduce the firm-specific risk until there is only market risk left over. Thus, going from 1 asset to 5 assets has a big impact on reducing our firm-specific risk. Going from 5 assets to 15 assets is also going to have a big impact on reducing our firm-specific risk. but likely a little less than going from 1 to 5. However, going from 130 assets to 150 assets, is probably going to barely move the needle as we have eliminated most of our firm-specific risk already when we held 130 assets. Think of a situation were you go from owning just Microsoft to dividing the portfolio into Microsoft, Exxon, Target, Ford, and Moderna. We went from one stock (if Microsoft disappoints our portfolio tanks) to owning 5 stocks. Now, if Microsoft only represents 20% of our portfolio and reports bad results, we’ll still feel it. However, much less so when Exxon, Target, Ford, and Moderna are not reporting the same bad news. However, if inflation goes up, that’s going to impact all the companies (not necessarily to the same extent). Now imagine you own Microsoft and 99 other companies. Even if Microsoft declares bankruptcy tomorrow, you still have 99 other companies to offset it. Essentially, Microsoft goes from 100% of your portfolio to 20% of your portfolio and then down to 1% of your portfolio. Clearly, the impact of what happens to Microsoft is going down dramatically as we add more stocks to the portfolio, but at a decreasing rate.

We’ll end the academic portion here and jump back into the real world where things are always quite a bit more messy than we want to believe.

Historical Data Doesn’t Imply Future Data

Some parts of historical data are more reliable than others. We have historical returns (which are not 100% worthless, but probably close), historical variance (which is more reliable) and correlations (which are reasonably reliable, but are going to tend to move towards historical norms). Look at the data in the 5-year returns for some of these companies along with what’s happened since 2021.

• Returns are very unpredictable

• Standard Deviations are more predictable (maybe the most predictable)

• Correlations are likely to stay high (within industry) or move toward the mean (out of industry)

Unfortunately, changing the returns will greatly throw off any optimization attempts regardless of how well standard deviation and (to an extent) correlation track. Also, while standard deviations do tend to be much more predictable, correlations will move towards the average for the mean. Granted, this is a REALLY small sample size (too small to be meaningful beyond merely observation). However, it is using actual data from real companies and I selected the data in early 2021 to make the original spreadsheet. The return data is since that time. We can probably use other tools to estimate required returns and correlations while using historical data for returns which will help quite a bit. Yet, the “optimal portfolio” over a previous period is not going to be the “optimal portfolio” over the upcoming period. This is due to your three inputs (return, standard deviation, and correlation) changing.

Companies Evolve (Up and Down)

Let’s look at Meta (aka Facebook). It has gone from a basic social media company to a company with Instagram, Whatsapp, Oculus and is trying to create the metaverse (along with several other competing companies). The company that came public in 2012 is not the same company that is competing today. Therefore, we need to take a look not at what has been, but what we expect to be over the next few years.

Some restaurants thrived in the shutdowns of COVID (such as Chipotle) and others closed down because they weren’t designed to operate in a digital ordering process. Walmart did not do deliveries, but they do now. Peloton suffered from COVID (in a classic pull ahead move that many didn’t fully recognize) as people ordered bikes and signed up, only to get tired of them a year or so later. Companies evolve up and down over time and our goal as analysts are to forecast these changes.

This is easy in hindsight, but MUCH, MUCH more difficult to do in real time as the changes come very quickly and from a lot of directions. Don’t think in terms of “this will happen”. Instead, think in terms of probabilities (again, much more difficult to do in practice as our mind wipes probabilities away pretty quickly). Keep a journal and write down what you think is going to happen, when it is going to happen, and how likely it is going to happen. It will be ugly, but the only way to improve is to know how far off and in what direction you were.

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Jump Back to mid-2019

Let’s take a short trip in time back three years. How likely did you predict COVID, Federal Stimulus throughout COVID, January 6th, Ukraine-Russia, high inflation, or any other of the big events that occured. I’m guessing you assigned pretty close to a 0 probability on any of these events (heck, things like COVID weren’t even on your radar). Yet, they turned out to be defining events (definitely not the only key events) over the past three years. Each of these impacted the expected return, standard deviation, and correlation of your securities, but was likely way off your radar. Which means what things THAT YOU ARE NOT THINKING ABOUT now are likely to impact your forecasts? Something that you may try is to add to your investing journal what things are not currently on your radar (even if unlikely) may have a big impact on the expected return, standard deviation and correlation of your investments.

Correlation Can Be Messy

We use correlation to tell us how closely two variables move together in a linear manner. Which usually works fine, but can also be messy because there may be reasons why they don’t move in a linear fashion. Consider the following correlation tables and you can see examples where correlation can be misleading.

We often think of correlation along the lines of the top set of examples. However, if you look at the bottom set, you’ll see that correlation implies how closely the variables move together in a linear fashion. Now, it is typical to see examples like the first row (well, not really 1 or -1, but we often see data between 0.8 and -0.2. Remember that if your past observation was estimated to be -0.2, it is probably more likely to be a data artifact and the real correlation is likely going to be in the 0.2 - 0.3 range. If your correlation was in the higher end, it is likely to be in the same industry or a data artifact as well.

Can You Have Too Many Assets?

The answer is both yes and no. If you have the ability to make some meaningful predictions that turn out (on average…no one is getting every pick right) correct, then yes. You don’t want to own Peloton as it plummets from $165 back in early 2021 to $10.50 today or Shopify as it goes from $1700 to $350. These are some ugly routes that would be nice to avoid. However, and I can not stress this enough, it is easy to call Peloton too expensive at $165 after it is down to $10.50. It is far more challenging to think that it was actually worth $10.50 when it was trading for $165. When it fell to $100, did you think it had fallen far enough? How about when it hit $50? By far more challenging, I mean that no one did (at least not publicly). How about Bitcoin at $65,000 (now around $23,500) or some of my holdings (Amazon, FIGS, Facebook, and more)?

Don’t assume that you would have made the prediction that AMC was undervalued when it went from $2.18 on January 14th, 2021 to $20.36 on January 27th, 2021. That is an 833% return in two weeks! Then, the next day it closed at $8.63 for a drop of 58%. Perfectly normal, amirite? On June 2nd, 2021, it hit it’s high of $72.62, up about 3231% in 6 months (that is NOT a typo!). Today, it’s back down to $11.50. What the heck was happening? If you take out the escalator ride, how did a company that was on the verge of bankruptcy end up being up by 420% in just under 18 months? The answer lies in the ability to raise capital once the shares were higher.

Notice what happened during 2021. AMC raised as much capital by issuing 11.55 million shares for $50.86 — over 140% more than it raised by issuing 4.3 times as many shares (50 million) on January 25. The power of reflexivity in action.

Conclusion

Yes, you can have too many assets if they are not a part of your optimal portfolio. In other words, if you don’t have an edge in predicting expected return, standard deviation, and correlation over time. It’s like assuming because you understand the basic rules of poker, you’re going to win the World Series of Poker. Guess what? 90% of the people playing are in the same position (I’m sure there are a few suckers, but fewer than you’d hope)! The problem is figuring out what exactly IS your optimal portfolio because yours will be different from mine. It will depend on how active you want to be. Do you want to make a bet on energy? You can do that with ETFs, but then what happens if you overweight energy and it earns below market returns or has a much higher standard deviation?

If you want peace of mind, own a truly diversified portfolio in tax-sheltered accounts and add to it for 35 years. If you want to dive into the twirling waters of madness (and I’m there with you to an extent) known as investing, be prepared to get wet! Just recognize that you are likely going to learn a lot more, rather than earn a lot more.

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One of the Substacks that I started reading recently is Moontower. It came to my attention about a month ago when he cited one of my posts…and my subscription numbers started jumping. Hey, if you have 160 subscribers and the number jumps to 200+ in a week, you’re probably wondering what the heck just happened. So, first of all, thanks Kris for the big plug. If you haven’t looked at this one, it is worth a look. I’ll be honest, a lot of it goes over my head. Not issue #152, but take a look at issue #148 for a better indicator. This one goes pretty deep into macro policy and MMT (with the following disclaimer):

Macro is the raw material for story-telling. For marketing. It’s a political battering ram for both sides. But macro is a ball of yarn. The discourse that’s consumable is reduced so much to aid absorption that the logic, by necessity, ends up sounding unassailable. It must. The logic is solving for convenience. Not understanding.

So I don’t write about it because I don’t think it’s especially useful. It’s more likely to give you brainworms by beefing up your priors. It will calcify hunches into commandments when the evidence only merits “things to learn more about”

So, let me return the favor with a link to a great video in his current podcast. Ideally, subscribe to his Substack. It’s well worth the price (did I mention that it is exactly $0.00?). Here is the video (with full credit to Kris for finding it). Before you watch, it is a great article on the role of luck and talent. The video shows talent/hard work is important, but we as a society greatly understate the importance of luck (and there is a lot of it out there) in our success.

Take special note of the story on NASA astronauts (about 3:30 in) where each candidates score is based on 5% luck and 95% skill. On average, out of 11 astronauts about 1.6 are make it based on their skill and anywere from 9-10 make it based on luck! Which means if your life is turning out positive, take the time to remember that you’ve probably experienced quite a bit of luck in your outcome (along with your talent/hard work). As mentioned in my previous pod, there’s a reason that faculty members are 25 times more likely to have faculty members for parents!

When Better Is No Longer Good

Last week I was reading a news article (something that happens less and less frequently over time as “news” has taken on a big promotional view) and came across a story titled “‘‘Everything Is Terrible, but I’m Fine’”. It talks about the growing chasm between our personal well-being and what we think society is facing.

Note the huge dropoff in 2020 as the general perception was “I’m doing well”, but our impression was that the local/national economies tanked. The same held for 2021 (although interestingly the local economy bounced back a bit, but national economy grew worse). There are reasons for this such as COVID, stock outages, inflation, battles over “to mask or not to mask”, and a general sense of dread. Heck, we even had the murder hornets kick in.

The point is that the general sense was the economy was collapsing. It did (temporarily). Then bounced back relatively strongly. Here you can see a chart of Real GDP Growth (real is preferred to nominal to control for inflation) over the past 5 years. The purple line represents an approximate (as in a 30-second eyeball sketch) trend of growth which we are only slightly below.

So, is the economy a little worse than in 2019? Sure. Is it a lot worse? Probably not. One of the things potentially holding things back is a lot of people (and this is not a judgment call) have reprioritized their need to work (says the guy who retired earlier than he planned) which is creating a bit of a labor shortage (or labor opportunity). The “Great Resignation” shows that a lot of people are quitting their current job…to get a better one!1 From the article, we have this quote:

The data suggests people aren’t quitting their jobs to exit the labor market and sit on the sidelines, economists said. Instead, the high level of resignation indicates a strong job market for workers with ample opportunities, they said.

There were almost 11.3 million job openings in January, just shy of December’s record, according to the Labor Department.

The high labor demand is pushing employers to pay higher wages as they compete to attract talent, and that higher pay is luring workers away from their current jobs.

From the original article, you may remember the original quote from 2016

The Fed asked respondents how they would pay for a $400 emergency. The answer: 47 percent of respondents said that either they would cover the expense by borrowing or selling something, or they would not be able to come up with the $400 at all. Four hundred dollars! Who knew?

Now we read this

Self-reported financial well-being increased to the highest percentage in the nine-year history of the survey. As for that $400 emergency payment, more than two-thirds of adults now say that they can make it. This key measure of financial security improved 40 percent, during a pandemic.

We also see this:

So, we have more job opportunities and more money, but there is still a malaise that causes us to view OUR situation as good, but everyone else is struggling. What is the cause of it? A big part of the answer is human nature. Remember my philosophy (borrowing from the great Jim O’Shaughnessy)…you’ve got a hot shower and aren’t eating cold rice and beans for a week, life is really pretty damn good. That said, human nature is fine-tuned to be on the lookout for danger. Consider a recent post by Gurwinder (edited for brevity)

Offence and outrage once served us well, but as time has gone on, many new personal, social, and political boundaries have been created, and with them, the list of things to be offended and outraged about.

Firstly, the online attention economy ceaselessly barrages us with new outrages, from news of injustices to awful opinions.

Secondly, society is constantly inventing new injustices, typically for political reasons. Take, for example, the word "retard." Many people find this word deeply offensive, and if you ask why, they'll say because it was historically used to classify people with mental disabilities. That sounds like a perfectly reasonable explanation, until you ask them if they have a problem with the word "idiot" or "imbecile" or "moron" or "cretin."

The combination of the digital age constantly exposing us to new outrages and cultural elites constantly creating new outrages out of nothing has skyrocketed the number of outrages we now face.

Notice all the ways in which we can be easily outraged that are probably a bit more difficult than the world of 150 years ago (before radio, TV and the Internet/Social Media). In 1873, how outraged was the average person in Minnesota (which became a state in 1858) about the Bloody Benders (and seriously, take a look at the article if you aren’t familiar with the grisly details) in Kansas? My guess is that most of them never even knew about the case.

We don’t often hear the “good” news.2 Instead, the fact is that bad news invokes a bigger reaction. From a recent NY Times piece we see the following:

The coverage by U.S. publications with a national audience has been much more negative than coverage by any other source that the researchers analyzed, including scientific journals, major international publications and regional U.S. media. “The most well-read U.S. media are outliers in terms of their negativity,” Molly Cook, a co-author of the study, told me.

When the researchers examined which stories were the most read or the most shared on Facebook, they tended to be the most negative stories. To put it another way, the stories that people choose to read skew even more negative than the stories that media organizations choose to publish. “Human beings, particularly consumers of major media, like negativity in their stories,” Sacerdote said. “We think the major media are responding to consumer demand.”

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There’s also this article from the Los Angeles Times (which did a great job of avoiding the WEIRD problem).

To get a more global view, the scientists recruited 1,156 people in 17 countries: Brazil, Canada, Chile, China, Denmark, France, Ghana, India, Israel, Italy, Japan, New Zealand, Russia, Senegal, Sweden, the United Kingdom and the United States.

Each participant was shown seven randomly ordered BBC World News television reports, some of which had a negative tone and some of which were more positive. As the participants watched, the researchers monitored their heart rates and their skin conductance levels (essentially, tiny fluctuations in their sweat levels, which could indicate a person’s fight-or-flight response levels).

The researchers found that, on average, a slight majority of viewers demonstrated a bias toward more negative news. This largely held across countries and cultures, Soroka said.

Interestingly, of the three possibilities (no difference to bad or good news, preference for bad news, and preference for good news), the ratio of perceived preference for bad news (taken from heart rates and skin conductance) showed that about 60% had a bigger reaction to bad news. It would be interesting to see how much of that is internalized to the United States vs. the rest of the world. My guess is that it is higher here.

If We Decide We Want Bad News, Capitalism is Going to Make Sure We Get It!

One thing we’ve discovered from years of capitalism is that what we want is going to be really easy to get. Markets do a tremendous job of figuring out exactly what we want and providing it. This is true in snack foods, derivatives, entertainment, and even news. Innovation can create wonderful products (such as COVID vaccines, cancer treatments, new video games, and even these babies).

It also can create things like synthetic collaterized debt obligations which ultimately becomes a thing that few people understand — even if they are trading them.3

The problem is that CDOs rely on each of the tranches (levels, or pieces) of the underlying portfolio being accurately graded, that is, that one can reliably determine what the credit risk of a given mortgage is. Since mortgages are anything but transparent, it is hard to adequately price the credit risk of a given mortgage.

So, CDOs are, at best, problematic.

So, now enter synthetic CDOS.

What, exactly, is "synthetic" about them? "Synthetic" here is used metaphorically: it is a technique in finance which simulates one kind of asset by using other assets. There are things called synthetic calls, etc. So, a synthetic CDO uses credit default swaps to simulate the underlying mortgages of a regular CDO. As you can imagine, this is even more fraught than a plain CDO because it adds yet another level of complexity to an already-complex financial instrument.

Unfortunately, I don’t have a solution to getting better news. It is a topic that is discussed in quite a few places (as you can see in the above). However, my recommendation is to institute a few basic rules (which are pretty common suggestions):

• Don’t get “outraged” over social media posts. Facebook, Twitter, Instagram, TikTok, and countless others all have posts designed to inflame (because the political scandel of the day is much more exciting than another post on arithmetic vs. geometric returns). It generates likes, gets shared, and attracts “engagement” which is a big factor in social media.

• Tailor your social media feeds. I hear so much about how Twitter is a cesspool (and I do occasionally see it around the edges). However, the key is to stop following the people that make it a cesspool (shocker, I know). It’s like rubbernecking an accident scene. Clean your feed of toxic trash! My Twitter/Facebook feeds are pretty small, but the news/noise content is much better.

• Disengage from the news. The national news is going to make you enraged and there’s not much you can do about it. Don’t like what Trump or Biden are doing? Well, remember to vote, but ultimately you’re going to spend more time upset than accomplishing anything. Do things that make you happy and provide fulfillment. Whether it is going for a hike, enjoying a bike ride, doing woodwork, volunteering to mentor, learning to play guitar, or thousands of other positive activities. We have a limited time here — find things that make you happy, rather than things that make you upset.

• If you’re getting your news from things like MSNBC, Fox News, National Review, Rachel Maddow, etc. you are getting skewed news designed to get you upset. Instead, focus on things like AP Reuters, BBC, WSJ, and ProPublica (a little liberal skew, but more analysis).

Like I said, there is nothing earth-shattering in that list. Probably the most important aspect is to limit your news flow and instead focus on doing things that will make you feel better. Anyone want to join me for a 200-mile run in 2023 in Nebraska?

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First, a simple disclaimer, I am NOT a gun expert. I was probably a teenager the last time I held a gun, so PLEASE feel free to point out mistakes/errors in my reasoning (because I’m sure that they are there). This is part of the “Tips to Being a Better Human” that I am working on. I am open to feedback (you’ll find I’m likely to offend both sides of the gun debate which says absolutely nothing about whether or not I’m correct) and I’m trying to “Care More About Getting To Correct Than Being Correct”.

Plus, for those paying attention, I lied. I said that this week was off, but didn’t want to miss the chance to add to the other 1001 pieces on gun safety this week. 🤣 Seriously, this is an important enough topic that one more piece can’t hurt and, if you’d like, feel free to skip it (really, feel free to hit the delete…no hard feelings). We’ll be back with a regular article soon.

What We Know — Part One

The Uvalde shooting was stopped by a “good guy with a gun”, but not all go down this way. The actual number of deaths of shooters is about 32% who killed themselves (likely as law enforcement was closing in), while less than 9% are killed by law enforcement (almost identical to the number that are unsolved). The other 51% are taken into custody by law enforcement (from 2009-2020)

Thirty-two percent of mass shooters, or 92 shooters, ended with the perpetrator dying by suicide, and another 24 shooters were killed by responding law enforcement. The remaining 145 mass shooters were taken into custody by law enforcement, while the outcomes and identities of 23 remain unknown.1

There have been more shootings in the last two years (and will be more to come). There also were shootings/killings well before 2009. This is not an exhaustive list.

First, let’s look at the possibility that a “good guy with a gun” will be successful. When you have people with extensive and regular training (which takes time and effort), it is far more likely2. However, what if they do not have recent, active gun training? Take a look at this video (sure, it’s comedy and it’s a few years old, but there’s a lot of good data in there).

• At about 5:35 into the video, there’s a scene that shows Klepper getting shot under multiple scenarios. The reason is simple, he’s not trained.

• Dr. J. Pete Blair, Executive Director of ALERRT adds some of the following commentary:

  • About one out of every five active shooters gets stopped by a person on the scene and many of those people are unarmed.

  • About 3% of shootings (again this is dated…it appears to be a little over 8% now) are stopped by “a good guy with a gun”.

• At about 7:30 into the video, he goes for more active training. This time, two instructors (Coby Breihn and Aaron Vetter) explain that “there’s never enough training” and “it’s not so much a destination, it’s a journey.” So, he took another 4+ hours of training and…got destroyed some more.

• He determined that “Being a good guy with a gun is starting to feel way more complicated than movies, video games, and politicians make it seem”.

• In one telling comment, he says “That’s it. Being a good guy with a gun takes a lifetime of commitment to training.”

In other words, it is not your average NRA member holding up pictures of their assault rifles3.

It is heroic people that work hard at their craft (as in multiple hours per month) to develop the skills necessary to clear rooms, avoid shooting innocent people, take clear shots when the opportunity presents itself, and all the other necessary skills to do the job well. To those both heroic enough AND willing to put in the training time on a regular, continual basis, you deserve far more thanks than you get…so THANK YOU!! However, if you are not putting in the regular training (like 10+ hours per month…not just shooting targets), you are a guy with a gun (despite your best intentions) and more likely to cause harm than good.

What We Know — Part Two

Another big cry is that this is a mental illness issue. Which is obviously true as you don’t have sane people shooting up churches, schools, and grocery stores. However, we (we being the US for my global readers) need to acknowledge that mental illness is not one or two people in the US. Instead, we have over 1 in 5 adults (53 million) who suffer from mental illness!4 That is as of a certain point in time. Many people end up experiencing mental health challenges at different times in their lives so the number is likely larger. You know what else covers a little more than 30% of the US population? Gun ownership. According to the article, about 72 million people (give or take a few million on either side) profess to owning a gun and there are 330,000,000 million in the US.5 Neither are likely to just go away. I’m more than happy to see mental health encouraged and supported at the national level. That said, talking about improving mental health and following through on the push to increase mental health are not the same thing.

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What We Know — Part Three

Ready to be depressed? Let’s say that we eliminated mass shootings today. WOW! That would save about 2000 people since 1999. Maybe 2100 if we extend to 2021. While that is a lot of people, we have lost about that many to the flu.

While relatively rare, some children die from flu each year. From the 2004-2005 season to the 2019-2020 season, flu-related deaths in children reported to CDC during regular flu seasons have ranged from 37 to 199 deaths.

and

During 2019-2020, for example, 199 deaths in children were reported to CDC but statistical modeling suggests approximately 434 deaths may have occurred.

Essentially mass shooting are awful and we should seek to reduce that number. However, unfortunately, there are a lot of awful things out there (including the flu, cancer, drownings, suicides, drug overdoses, etc. Specifically, here are the numbers. In 2018, there were 19,660 deaths among kids from 1-19. That means that there were about 10 times the deaths IN ONE YEAR than the number of people killed in mass shootings in the previous 20 years. Again, I’m not saying don’t worry about mass shootings (they create both physical AND mental problems), but that death is a crappy part of being alive.

Domestic violence is another problem. Of the mass shootings between 2009 and 2020.

In at least 53 percent of mass shootings between 2009 and 2020, the perpetrator shot a current or former intimate partner or family member during the rampage. These domestic violence-related mass shootings resulted in at least 632 people shot and killed and 106 people wounded, amounting to almost half of all mass shooting deaths and one in ten injuries.

and

Too often, children and teens are the victims of domestic violence mass shootings: Of the 362 children and teens killed in all mass shootings in the past 12 years, nearly three in four (72 percent) died in an incident connected to intimate partner or family violence.

The findings about domestic violence-related mass shootings and where mass shootings tend to occur are interlinked. Nearly all of these domestic violence-related shootings involved at least one victim in a private home (93 percent), and 80 percent of them occurred there entirely and never moved into a public space.

There are three important aspects to note here:

• that domestic MASS shootings (ignoring one-on-one domestic violence) accounted for the deaths of 632 people…almost half of the people killed (including the huge shooting in Las Vegas in which 411 people were wounded by gunfire).

• the second issue is that these incidents AND school shootings are often (not always) connected to people that know who they are killing. These appear random, but are rarely so.

• the third issue is that domestic violence actually accounts for a higher percentage of children’s deaths than other forms of mass shootings.

In other words, domestic violence drives more death than traditional mass shootings!

What We Know — Part Four

Gun violence has little to do with mass shootings. Instead, it is basic homicide and suicide that account for the bulk of problems. If we remove the mass shootings of about 2000 people over several years (which again is much harder to do mentally as the images are both scary and draw lots of debate) the numbers are still a lot bigger for gun deaths.

In 2020, the most recent year for which complete data is available, 45,222 people died from gun-related injuries in the U.S., according to the CDC.

If we want to reduce gun violence, we probably need to focus on controlling more traditional gun issues. How do we reduce suicides (which accounted for 24,400 gun deaths in 2020) and homocides?

One solution is presented by David Epstein in his update on gun violence (as mentioned earlier, there’s no shortage of those over the last two weeks…but his is worth reading)

A common argument, though, is that if those people didn’t shoot themselves, they would have just found some other way.

Ample evidence (like this, and this) points to the contrary — that easy access to lethal means, like guns, increases the numbers of deaths by suicide overall. As Harvard School of Public Health professor David Hemenway put it:

“Studies show that most attempters act on impulse, in moments of panic or despair. Once the acute feelings ease, 90 percent do not go on to die by suicide.”

This reminded me of the study by Richard H. Seiden of the University of California at Berkeley, in which he followed up on 515 people who were planning to jump from the Golden Gate Bridge, but who were restrained and prevented at the last minute. Many years later, 94 percent of those people were either still alive, or had gone on to die of natural causes. A lot of suicidal behavior, Seiden wrote, “is crisis-oriented and acute in nature.”

Easy access to a gun greatly enhances the success of a suicide attempt. However, the vast majority of the data shows that this is far more likely to represent a temporary moment of crisis. If we could stop 10% of the suicides, we’ve saved more people in one year than we’ve seen killed in mass shootings in the last 20 years! Honestly, that is astonishing to me and something that might surprise quite a few people who see news reports of mass shootings (or maybe not). How many homicides could be eliminated by reducing the availability of guns? Maybe 5-10% (it won’t be a high number), but I’m guessing it is not a non-zero number.

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Solutions (Maybe)

First, those that are liberal need to stop talking about appealing the second amendment. There are multiple reasons (home defense, hunting, sport shooting, and more) that people want to have access to a gun. Repealing the second amendment is not going to happen (and shouldn’t). Fortunately, most liberal politicians (not all) recognize this. The problem is that political tribalism is so strong that conservatives don’t trust their intentions…and there is no solution to political tribalism. Both sides get so caught up in fighting each other that they see compromise as defeat.

Age

One big problem is that we have people with guns and their brains are not fully developed. Consider driving. We are able to get a driver’s license in the state of Missouri at 16. However, driver fatality ratings don’t slow down until you are 24!

Among the youngest drivers (under 25), the number of licensed drivers steadily increases from age 16 to 24, while the overall crash rate per 100,000 drivers steadily decreases. The fatal crash rate remains relatively flat from age 16 to 22 and starts decreasing for 24-year-old drivers.

Why are young people more likely to get in car accidents than older people? Two reasons — one is that they have less experience, but brain formation also plays a big role. Our brains do not stop fully developing until they are 25 (it’s not as if the birthday is a magical date…instead, think of it as probably 22-27).

Some more data on age (as in under 18-year olds) from the Nationwide Childrens page:

• Nearly 1,300 children younger than 18 years of age die from shootings every year.

• 1 in 3 families with children have at least one gun in the house. It is estimated that there are more than 22 million children living in homes with guns.

• Most of the victims of unintentional shootings are boys. They are usually shot by a friend or relative, especially a brother.

• Nearly 40% of all unintentional shooting deaths among children 11-14 years of age occur in the home of a friend.

• Adolescents are at a higher risk for suicide when there is a gun in the home.

• Some parents believe that hiding their guns will prevent children from accessing them. However, 75% of children who live in homes with guns know where they are stored.

• Many parents think their children are not capable of firing a gun. However, children as young as 3 years old may be strong enough to pull the trigger of a handgun.

• Parents believe their children know the difference between real guns and toy guns, but in 16% of unintentional firearm deaths among children younger than 13 years of age, the gun was mistaken for a toy.

• Parents often believe their child would not touch a gun because “he knows better.” However, studies have found that most children will handle a gun if they find one, even if they have been taught not to.

Which makes one wonder why we can legally purchase firearms on our 18th birthday? Part of the reason is due to military participation and traditional entry to adulthood. However, maybe we should consider raising the age to 21. Is it perfect? No, but it is probably a better match to what we know about brain development.6

Follow the Restrictions in Place

How can we complain about stopping gun violence when we don’t even follow the rules?7 Granted, there are ample reasons why rules are not always followed. However, we should be making a bigger effort to be enforcing those that are in place while adding a few simple new ones.

Add New Regulations…and Enforce Them

There are probably a few reasonable gun regulations that we can add. These will NOT stop mass shootings (nothing will). The goal is not zero-one, life rarely works like that. Instead, the goal is to REDUCE mass shootings and, most importantly, reduce gun violence that does FAR more damage to society.

• Universal Background Checks. This means that you face a complete background check on any gun purchase, regardless of whether it is at a commercial dealer or a private gun show (purchases at private gun shows are not required to perform a background check).

• Domestic Violence. If someone has been convicted of a federal gun charge, they should not be allowed to own a gun. Seems simple enough (and is a federal law), but some states (such as Missouri) have chosen not to enforce it. Does this mean people with domestic violence charges will not own guns? Of course it doesn’t…clearly they aren’t law abiding citizens. However, it does mean that if they get caught with a gun, they ARE violating the law and can be dealt with accordingly, regardless of what else they are doing.

• Magazine Size Restrictions — There are currently eleven states that have capacity limits on guns. I would think 10-15 rounds would be sufficient and would at least require a magazine switch.

• Training — Having a brief training sessions (somewhere in the 2-4 hour range) every 5 years to be permitted to carry a firearm doesn’t seem unreasonable to me. Maybe a 6-hour session for all new gun owners (even if half the clientele already know about where their safety is) that goes through proper storage, basic gun safety, how to shoot, etc. seems reasonable. The idea is that gun safety requires a little bit of knowledge about the product. Sure, the gun user can find more information online in 15-30 minutes than they’ll get in a training session, but having people understand their weapons doesn’t seem like too much of a stretch. These could be offered by the gun seller or by other responsible parties.

Closing Arguments

Americans have recognized the importance of guns in many arenas ranging from home defense, personal defense, hunting, etc. Even though I don’t carry a gun, I have zero problems with these uses. That said, we need to recognize that someone armed with a gun is more dangerous than someone armed with a barb-wired wrapped bat.

The good news is that we are making progress. Your Local Epidemiologist has a great recent article that shows a lot of progress has been made since the Sandy Hook and Parkland shootings. Seriously, take a look at the article as she does a great job in writing it. One of the highlights is that “states with more restrictive laws have reduced the rate of mass shootings.” We can move the needle…and are doing so. It won’t be overnight, but it can be accomplished as long as we are addressing the right issues. If you want to see mental health improvements passed, I agree 100%. However, helping people have better mental health is not going to really move the needle (mainly because it is an entirely different issue). You’re not going to “harden” schools to the point that mass shootings go away (they aren’t all schools). Instead, focus on issues that make “the good guys with a gun” ACTUALLY BE “the good guys with a gun”. Training, universal background checks, smaller magazine sizes, improve age restrictions, etc. These are doable goals that will greatly enhance US gun safety if they are pursued over the next 10-20 years through active participation.

Apparently there are two new factors that have led to quite a few new subscribers to this little pond of the Interwebz that I take up space writing my, (mostly) weekly, thoughts on different topics. One is recommendations — an incredible tool by Substack to promote fellow writers. The other is a specific mention by the author of Moontower (honestly, I didn’t even have to pay him 🤣). Thanks @KrisAbdelmessih. Anyway, I’m now over 200 subscribers, so thanks to the new and the old subscribers for getting an occasional email that allows me to chat about different things that I enjoy. Please feel free to share any of these posts that you enjoyed.

Also, if any new subscribers want to share a bit of their story, I’ve done a couple of interviews with former students. Here’s one with Khalen Dwyer and one with Trevor Johnson. These are a great way to introduce me to some new people and I can learn more about their (or should I say your) successful journies. Plus, they are relatively easy to put together because you’re doing the work (laziness can be an attractive trait!). If you’d be interested, just let me know.

No Update Next Week

This is the first day of chemo (month 3…only 9 more to go once this is done!) and I can feel the sleepiness kicking in already. Some of the new subscribers are thinking “Wait a minute, we’re reading stuff from a guy with hole in his head?” Yes, a case of oligodendroglioma — say that three times fast — had me on the operating table on Christmas day (what’d you do on Christmas?). Fortunately, they think it was there for awhile, so apparently we’ve gone a few years without signs…make of that what you will. 🤣 Anyway, it’s being treated now and looks like I’ll recover fine (no comments from the peanut gallery). We’re going to take next week off and then I should be back the following week. Thanks for putting up with a bit of a hectic schedule.

What Is the Future of College — and Does It Have Room for Men?

Freakonomics took a week off to revisit abortion (yes, there ARE topics that are even too controversial for me to touch!) and then came back with episode four of college (the final one). If you missed last week’s episode, please hop back and read that first. I debated whether or not to include it and decided it was worth covering as it addresses a pretty relevant topic — are we leaving young men out of the educational experience — along with an intriguing look at the connection between student-faculty-employer and certificate programs. So, we’re back to college for one more round. Here Stephen Dubner introduces the topic (and a huge shout-out to Stephen Dubner for all he does with Freakonomics and such…really, consider taking the time to subscribe/listen to the episodes as it is well worth it!)

What is the long run for higher education in the U.S.? If we were asking that question 10 or 15 years ago, the answer would have been easy: “Things are looking up,” we would have said. Enrollment is up. Investment is up. Belief is up — belief that college is easily the best route to achieving the American Dream. But today, it’s a different answer. For the first time in modern history, overall college enrollment is down. Belief is down. And if you’re a college graduate looking at the size of your student loans, you’re probably feeling down too. This is the final episode in a series we’re calling “Freakonomics Radio Goes Back to School.” So far, we’ve told you how American higher education has two distinct models.

Ruth SIMMONS: One model is about eliminating people so that there is a special class of achievers at the highest end. The other model is about making sure everybody gets through. 

We told you how that first model, the elite model, has been accumulating ever-more resources while educating an ever-smaller share of U.S. students.

Morty SCHAPIRO: Educating a very small sliver of the American population who already get tremendous resources allocated to them.

Those elite universities are generally thriving; demand for admission has never been higher. But what about everybody else? What about the less-prestigious privates; what about the four-year publics; what about the community colleges and trade schools, the H.B.C.U.s? Today on Freakonomics Radio, we take a look at this second model of higher ed., and why for so many people it is no longer working.

Donald RUFF: To see $100,000 as a debt burden is daunting. 

We look at why men in particular are skipping college.

Amalia MILLER: Typical boy behavior doesn’t fit as well with good student behavior.

And we find out if the Lewis College of Business can make a comeback.

EDWARDS: All we did was borrow from nursing schools and welding schools and electrical schools.

Do you still believe in college? We’ll find out, starting right now.

Let’s start with the debt burden which is (a) really high and intimidating, but also (b) not valid. Again, let me review the debt situation of college students from Credible.com.

The editing makes the pictures a bit hard to see, but I want to stress some things. First, the average student loan debt is $39,351. However, that is misleading as it includes graduate school, law school, medical school, and MBA programs which are significantly more expensive. Also, if we look at students who go to public schools (including graduate programs) the average debt load is under $28,600…we’ve now dropped the cost from $100,000 to $28,600. Finally, if we look at undergrads (granted, non-traditional students extend that, but they account for a small proportion of undergrads), we see that student loan debt is under $15,000 (yes, that does include community college so may be a bit too low). However, I think we can all agree that $15,000 - $28,600 is a LOT less than $100,000!

Again, this is one of those things that colleges NEED to do a better job of communicating. College is not cheap, but the idea of $100,000 in debt is also an example of poor financial decision making. Let me review Pittsburg State Universities tuition (and a reminder that I disagree with including room/board as part of college expenses) as an example.

Note that even if you DO include living expenses of over $1000 a month, you are not going to spend $100,000 on 4 years of college before we factor in financial aid. If you don’t include that, you are looking at $40,000 in total costs with NO financial aid. We can debate whether or not that is too expensive, but using student loans as a proxy for cost is not a legitimate proxy! We need to shift the focus to actual cost less scholarships, Pell grants, and other forms of financial aid that does not need to be repaid. Then we can talk about whether or not college is too expensive (which is an open question).

Shift in Demographics

One point that Stephen Dubner explores is the shift toward’s more women in the college classroom.

But here’s a number that certainly surprised me: Nearly 60 percent of all college students today are women. That’s an all-time high. And remember what we told you earlier, that U.S. colleges and universities have lost about 1.5 million students in the past several years? Well, men accounted for 71 percent of that loss.

Those are some pretty staggering numbers! Both the number of women and the declining enrollment of men. Dubner (and co-hosts) offer a number of potential explanations:

• Start a football team? I think this was meant as a joke, but not 100% sure.

• Demographics and workforce shifts. This is presented in a couple of different ways. First, there were 250 women’s colleges and now it is about 30. Also, the GI Bill caused a big shift of women coming back to college (which actually flipped the ratio to 2-1 men). However, it has now switched back to 60% women.

• Economic factors. This is actually my favorite explanation as it ties to rational behavior.

  • First, there has been a shift towards more women entering the workforce over the past 30 years. This typically (again, not always) leads to better opportunities for your career (and gets more women into decision-making authority).

  • Second, the relative gains for women are more substantial because they are starting from a lower entry point (part time, retail, etc.) which creates a greater potential gain.

That’s Amalia Miller. She is an economist at the University of Virginia.

MILLER: Why might more women choose to go to college than men? As an economist, the way you think about it is thinking about the net benefits, the costs and benefits of that decision. So, the benefit side of college could be the earnings you get as a college graduate, where the cost side is the earnings you don’t get, that you would have gotten. And it could be that that’s higher for women than for men. If you think about some of the non-college jobs in the service sector that women are concentrated in, these are some really low-paying jobs. Blue-collar occupations or jobs that paid a decent wage that didn’t require college, a lot of those were more male-dominated.

In other words, a man who doesn’t go to college might get a job in construction that pays well, whereas a woman who doesn’t go to college would be more likely to work in retail or perhaps as a home-health aide.

MILLER: It could be that even if college women earn less than college men, it was still more worth it for women because that gender gap was smaller. I think the problem with that explanation, though, is it doesn’t explain the increase for women compared to men in recent decades, where it doesn’t seem like blue-collar work has had great growth in terms of number of jobs or wages.

and

Miller and her co-authors found another significant result.

MILLER: What we find is that there’s a significant decline in women’s likelihood of being married in their late 30s if they attended a more elite school for college. If we think of marriage as a positive outcome, then this might suggest a bad outcome. On the one hand, there is this career advancement, but it happens at the expense of family formation. These women are less likely to marry, but when they do marry, they’re marrying men who are more educated.

Minority and Low-Income Students

I was fortunate when it came time to go to college as my parents were supportive of the experience and paid all expenses for the first four years!1 It is a lot harder for students without these opportunities. Whether they are low income or minority students, there can be more challenges in the way. One of the biggest is just recognizing that college IS a potential outcome and that there are ways to make this happen (such as Pell grants, needs-based financial aid, work-study, etc.). As a high school student, I KNEW that I would be going to college and was able to take classes to help prepare me for that experience. However, those opportunities are rarely there for kids with single parents, financial struggles, bad living environments, etc. (and I say this in generality…some of these students have tremendous drive, mentors, parents that refuse to let them slide, etc.). Consider the case of Donald Ruff. He is the interim C.E.O. of the Eagle Academy Foundation.

They operate five college-prep schools in New York City and one in Newark, New Jersey.

RUFF: Honestly, we saw what was happening in our communities with the young men in particular, not just the graduation rates, the high incarceration rates, as well as the influences of some of the more negative elements, including gangs. 

Their New York schools are part of the city’s Department of Education — which happens to be run by the Eagle Academy’s former C.E.O., David Banks. But as Donald Ruff tells us, his schools are different from the standard public school.

RUFF: One of the things that we wanted to do is actually create a school and a culture where young men could feel safe, where young men can authentically just be themselves, be boys. 

Another big priority is making sure their graduates get into college. In New York City, nearly 60 percent of all public-school students go straight to college. But that number is much lower for Black and Hispanic students, in New York and elsewhere.

RUFF: Just going back to 2019 as an example, the college enrollment rate was about 37 percent for Black students, 36 percent for Hispanic students, and 41 percent for white young men. And at that time, our enrollment rate was at 73 percent.

and

A college graduate is much more likely to be employed than someone who doesn’t go to college, and they earn more too. That said, there’s no guarantee, especially these days. Around 40 percent of recent college graduates are technically “underemployed,” meaning they have a job that doesn’t even require a degree — which also means it probably doesn’t pay very well.

This illustrates some of the challenges faced by minority and/or lower-income students who face challenges that a lot of students don’t have to worry about. Three quick comments.

• They mentioned that the pandemic affected students. This is true. The pandemic impacted EVERYTHING! Online education works for a relatively small portion of the population (more on this in a minute), but not the majority of them.

• Second, he mentions the $100,000 in student loans which is NOT reasonable unless you are using it to pay for every expense encountered over four years and not supplementing your income with any financial aid (most low-income, minority students are going to exhibit financial need).

• Third, there are underemployed people graduating from college (just as there are underemployed people graduating from high school). I’ve had students that decided to become moms (or dads…but more moms). I’ve had students that took my business finance class three times or graduated with the mimimum required GPA. Maybe not 40%, but easily 20% would fall in the category of people going to college for reasons other preparing for a career.

That said, consider this graph which shows the average wage for a college graduate ($52,000) vs. the high school graduate ($30,000). While these are NOT the same students (and an interesting debate about how much of the $22,000 per year is attributable to college would be an interesting question), I think seeing the cost of college around $40,000 and the net difference in salary of $22,000 per year makes college a worthwhile Net Present Value investment (see, even got a bit of finance in here 🤣).

Online Doesn’t Work

One of my revelations in teaching is just how poor of a tool online education is. There are things that I’ve been wrong about before, but this is probably one of the biggest. My initial view was that online education would wipe out traditional teaching. Feel free to stop laughing sometime in the next few minutes. It didn’t…at all. Here is a discussion from this week’s Freakonomics:

Teaching students online, however — that was supposed to solve this problem. It was scalable, it was efficient, it was cheap — it was perfect! There was just one thing: most people don’t like it. The best evidence for this was the Covid-19 shutdown.

Pano KANELOS: The whole world went online, and education went online, and we learned fundamentally that it just doesn’t work. 

That is Pano Kanelos, who used to be president of St. John’s College in Annapolis, Maryland.

KANELOS: Online education just doesn’t work, whether it’s for K-through-12 or in higher education.

That may be an overstatement — but there is evidence that online schooling doesn’t do what its boosters said it would. Some research has shown that students who go to class in-person do better on several dimensions than the ones who study online: The in-person students get better grades, they’re more likely to do the follow-up coursework, and they’re more likely to graduate. And some of these are randomized studies, so they’re not just measuring the differences between the kind of students who choose in-person attendance over online.

So, nope. At least as of now, online isn’t the answer. Maybe in a few years with refinements, it will be. However the current model works well for a handful of busy, dedicated students. It works awfully for most students. We just aren’t wired to put in the necessary time to learn what we need to know (which varies tremendously between a nursing student, a finance major, and a graphic design artist) in order to enhance our ability to perform. I’m not sure if it is the student-student interaction or the student-professor (or teacher) interaction, or the entire college experience (my money is on the entire college experience). However, something is missing.

Certifications and Credentialing

This is an interesting concept and would work great for the right students. We did a little experimenting with Certification programs at Pitt State and I think it was headed in the right direction, but there was still some work to be done. First, here is an overview with D’Wayne Edwards

What about all the other students, and potential students, who are looking for a more practical college experience? What if there was a place that combined a traditional college environment with a practical certification program — and what if the education was free?

EDWARDS: I didn’t go to college. There was no money. No money for me to go to college. 

That again is D’Wayne Edwards, whom we met at the start of this episode. He lives in Detroit now but grew up in Los Angeles, the youngest of six kids raised by a single mom. He’d always been a talented artist, and he loved designing sneakers.

EDWARDS: I discovered kind of late in my senior year I wanted to be a designer. And I didn’t know that you needed a portfolio. My guidance counselor didn’t know that. She actually discouraged me from being a designer, telling me that no Black kid from Inglewood would ever design shoes for a living.

DUBNER: As someone who grew up without college as an option, if you had not had this drive and talent for designing sneakers, what do you think you would have wound up doing?

EDWARDS: In Inglewood? Eighteen is a win if I can get there, alive or not in jail. Twenty-one? A miracle if I’m not dead or in jail. I have some friends that are not here anymore. I have some friends that are just getting out. That’s just part of growing up.

But thanks to his talent, and with the help of some teachers, Edwards took a different path. He went on to become one of the top shoe designers in the country. He spent many years at Nike, working with Michael Jordan and Carmelo Anthony; he got more than 50 design patents.

It’s important to note that while the benefits of college go well beyond learning a trade or skill, there are students that financially, mentally, and for a hundred other reasons don’t really need four years of college, but might be ready in one or two years (or even a few weeks) of focused training. D’Wayne focused on developing a shoe design program that lasted two weeks — “It was 14 days, 12 to 14 hours every day, straight through. We didn’t take a break. And the kids loved it. They didn’t want to leave.” Why? They loved this because it was what they wanted to do. They were working with someone who was well respected and it didn’t distract them with information that they didn’t care about.2

So Edwards taught professionalism.

EDWARDS: Simple things. Show up at 9:00 — 8:45 is on time. If you’re late, you do 50 pushups per minute. 

DUBNER: Get out of here! At school? 

EDWARDS: At school. And then it got to a point where the kids were like, “This is not fair.” So they were like, “Well, what about other options?” Actually a really good idea came from one of our employees, who was a former student. He was like, “You should make the students before the final presentation explain to the brand how often they were late and how many minutes they were late.” So now they have a choice — 

DUBNER: Push ups —

EDWARDS: — Or you admit your flaws to the person that’s trying to hire you. 

This is another area that a lot of schools are starting to offer — courses on professionalism. Things like showing up on time, table manners at a business lunch, working with others, etc. These are more important skills than many people realize. Grow up in the right environment and you learn it through osmosis.3 Grow up in a different environment and you probably won’t. Despite common perception, the average 22-year-old brain is not the same as the average 35-year-old brain.

Edwards doesn’t see himself as any sort of college revolutionary. He sees himself as someone who realized that college has become too expensive, too inaccessible, and too divorced from its original goals — and then he found a way to do something about it.

One key disclaimer is that these types of programs are not designed for students that want the full 4-year college experience. Instead, they are designed for programs that require specific training in conjunction with the industries that hire those students. It is a great model for the right student, but it is a piece of the overall model instead of a replacement.

Wrap Up

So, let’s go back to the question asked at the beginning of the article: “Do you still believe in college?”

My answer is definitely yes! That said, it’s a system that needs some changes. There is room for elite colleges, but as the numbers indicate, most students go elsewhere. As Stephen Dubner states

Fewer than 10 percent of them go to one of the elite schools at the top of the pyramid. The majority attend what are called mid-tier public or private four-year schools. About 25 percent attend a community college or other two-year school — although nearly half of all students start out at a two-year school. And nearly 10 percent go to for-profit colleges. Of the total undergraduate population, around 53 percent are non-Hispanic white, while 21 percent are Hispanic, around 15 percent are Black, and just under 8 percent are Asian.

So, let’s focus on state schools, regional schools, community colleges (although less as feeder schools and more as certificate/credential schools) and other programs. If a student starts at a community college and decides that they’d rather move to a four-year program, that is great. However, the sooner that they move to a four-year school, the better their college experience is likely to be.

Let’s spend more time working on online education. There is something there, but the current model doesn’t work. Maybe it won’t work. Maybe it will. However, the version being offered now doesn’t appear to be a valid model. One potential reason could be that we are still educating kids whose brains don’t fully develop until they are around 25-years old. While some are motivated (narrator — he was not one of them), most are not. Having faculty who care about the development of their students is not only important, but essential. Getting that student-faculty AND student-student connection into the curriculum is critical to success.

One last thought. Don’t confuse success of the student with success of the school. Every college graduates great students who would have been just as successful without college. Every college also graduates students who probably learned very little beyond how to party. These are the outliers. The more important part of college is how well we do at educating the average student with reasonable motivation. They may take a day off here and there. They may take not prepare for every exam or projects may not represent their best work, but overall they are learning from interactions with those that make up the college (other students, faculty, staff, etc.). They may have entered college with no idea what they wanted to do. I went to Iowa State for one semester to be a mechanical engineer before transferring to Northern Iowa as an economics major. I then “discovered” the stock market in my sophomore year with goal of only buying stocks that would go up (this would be funnier if it wasn’t true). It wasn’t until my junior year that I realized my future would have to do with finance and my senior year that one of my professor’s mentioned the possibility of a PhD that my career path became somewhat clear.4

So, do you have a story of YOUR college experience you’d like to share? If so, send me an email (kevinbracker@gmail.com) or leave some feedback to share YOUR story! Am I on track with my suggestions? Am I missing something (the answer is YES, but what am I missing)? Share your college experience and offer some feedback!

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Welcome to College

I love the Freakonomics podcast. Sometimes it can be a bit mundane, but still hilarious at times (albeit in a bit of some uneasy comedy…as is most good comedy). Such as this podcast on lawns.

Today, Americans spend roughly $60 billion a year in what’s known as the turfgrass industry. This covers lawn supplies, lawn services and so on. That figure includes sports fields, commercial properties and private lawns; lawns account for two-thirds of the total square footage. How much square footage is that?

40.5 million acres of turf according to Cristina Milesi.

What are these unbelievable numbers? The total was 20 trillion gallons per year. On lawn-watering. You want a little context for that number? Consider we use just 30 trillion gallons to irrigate all our crops. Next Milesi calculated how much carbon the turfgrass stores in the soil.

MILESI: Then I subtracted from it the amount of carbon that was associated with nitrogen fertilization and the amount of carbon that was emitted by using a typical lawn mower.

And: what’d she learn?

MILESI: I learned that the turf would become a sink of carbon. This is not surprising. A plant, given plenty of attention, photosynthesizes carbon. But it comes at the cost of producing the fertilizer, mowing the grass and all the industry that comes around it.

So even with those costs included, lawns look pretty good from a carbon perspective. On the other hand, Milesi’s model didn’t include inputs like the carbon emissions from the trucks that lawn crews drive, or the original manufacture of all that lawn-care equipment. Nor did it include the energy used to deliver water to households and clean it for human consumption.

MILESI: We should not forget that this is drinking water. I did not account for those costs.

And, as just about any economist will tell you, water is often woefully underpriced — which can lead to overuse. Especially if you’re growing a grass species that wasn’t meant to grow where you live.

So, when they decided to cover the issue of going to college, I knew that after spending about 30 years of my life preparing to be a professor and being a professor, I would be both nodding my head in agreement and cringing at some of the solutions proposed. So, let’s review the series of podcasts.

Why Go To College?

Here’s Stephen Dubner introducing the topic:

What if I told you there was one economic activity that is a silver bullet for income inequality?

Christina PAXSON: It is an equalizer that’s really important. 

And it’s not just income.

Morton SCHAPIRO: The monetary returns are really important, but that’s just the tip of the iceberg. 

Just about any economist you talk to — they all come around to that same word.

Peter BLAIR: Incredibly important.

Amalia MILLER: Very important.

Miguel URQUIOLA: Immensely important.

Can you guess the economic activity I’m talking about? Here’s a hint:

Ruth SIMMONS: You learn more in those four years than you do at any other point in your life. 

Yes, the activity we’re talking about is college. You probably don’t need to be told that going to college is important. Given the demographics of the Freakonomics Radio audience, it’s likely that you have a college degree — at least one — or you’re working on one. Despite the cost in time and dollars, our economist friends see college as one of the best investments possible. An investment for yourself:

Catharine HILL: If you can get yourself a college degree, your lifetime earnings are going to be significantly higher. You’re going to have better health insurance, you’re going to be more satisfied with your job. 

And a good investment for society:

SCHAPIRO: People who have higher education, they are much more likely to vote, they’re much more likely to volunteer, they’re much more likely to do all kinds of things that enhance the democratic process and the social fabric of the country. 

Let’s pause for a second here to recognize that I agree 100% with the emphasis on college…it’s incredibly important. Not just for your income (and we’ll come back to this), but there are so many other benefits to going to college that it is hard to truly capture the full experience. However, I want to stress three important aspects of college.

• It is not essential to having a successful career. There are plenty of “blue-collar” jobs (I’m sure there are others that detest the “blue-collar” vs. “white-collar” as much as I do, but I doubt that there are many who hate it more…tribalism sucks). You can have a great career through hard work, training, natural ability, etc. in jobs that do not require a college degree.

• You can be a great mom/dad, active in the community, and exhibit all the other benefits without going to college.

• College is expensive! There are likely ways to improve on this that don’t require foundations, student loan dollars, and other forms of government support. Ways that encourage learning and sampling to allow students to choose the transformative experience that allows them to excel. This is something that should be addressed.

Those disclaimers aside, students that choose to attend college and work towards learning (and I’m not just talking about academic issues), are more likely to

• have higher salaries (more does not imply always)

• be more open to people from different cultures (race, religion, political, social networks, etc.)

• better job benefits/perks

• have more advancement opportunities.

Are there exceptions to these rules? Of course there are! The idea is not that college determines your success, but instead that the college experience can be a significant factor in allowing you to achieve your success.

The first episode got bogged down into the Ivy League schools (and other elite colleges) where it is impossible to tell what people are paying due to competition, income of applicants, scholarships both need and merit, work-study attitudes and lots of other issues. However, if we look solely at sticker prices, we get the following picture.

I would argue that including living costs is irrelevant (whether you are going to college or not, you kind of need a place to live and food to eat). College expenses (books, calculators, software, etc.) are legitimate expenses, but universities do their part to keep these costs as low as possible. Consider Open Educational Resources.

I had the opportunity to co-write https://businessfinanceessentials.pressbooks.com/ with Fang Lin and Jennifer Pursley. Will the book become dated over time? Sure, but time value of money, risk and return, valuation models, etc. are not going to change dramatically. It’s free to use and you are welcome to modify/edit it as you see fit. Many other faculty do similar things to help students.

So, if we look at public college costs, you are looking at about $10,000 - $12,000 per year before any student aid. Not cheap, but not outrageous either, especially when compared to many private schools.

The University of “Impossible-to-Get-Into”

From episode 501, we have this story of the “prestige” factor:

Peter Blair began to wonder if colleges might be sending the same signal. Could this explain why the elite schools had essentially frozen their growth? He and Smetters began to create an economic model to explore this question. The model included three steps. First, students choose which colleges to apply to; then, colleges decide which students to admit; and finally, students pick which college they are going to attend. As you can imagine, there are a multitude of variables that affect each step: the total number of applicants, the academic and extracurricular quality of those applicants, as well as net tuition costs and other factors. And there was one special variable they included in the analysis, the same one that applies to luxury goods.

BLAIR: Universities are competing on what we call prestige, which is a relative measure of: how selective is my university relative to its peer institutions? 

Now Blair and Smetters took their model and fed into it real-world application and matriculation data from Harvard, Yale, Princeton, and Stanford. They did this twice — first with the “prestige” variable turned on.

BLAIR: We find that when we calibrate the model with prestige on, we’re able to fit the patterns in the data, which show that admissions rates have been declining at elite institutions and also the average SAT scores have been going up both for applicants and also for matriculants. So that’s with prestige on, the model fits.

In other words, their model successfully re-created the reality. Then they turned off the prestige variable. What’d they find now?

BLAIR: What we find is that in the absence of prestige, admissions rates would go up, the number of applicants would go up, the number of matriculants would also go up. The average test scores would go down slightly. Also, the number of applications per slot would in fact decrease. So competition would soften at elite institutions. 

In other words, if elite schools weren’t competing to position themselves as super-exclusive luxury brands, they’d admit more people, and it would be easier to get in. You could imagine this would make a lot of people happy. But who might not like it? Just guessing here, but how about the elite colleges’ administrators and faculty and alumni and current students, all of whom really like the idea that their school is so exclusive.

We also have this discussion on the prestige factor by students:

How much does reputation matter to college students? That’s a hard question to answer empirically. To get some anecdotal answers, we went up to Urquiola’s school, Columbia, which is currently tied for second in the U.S. News & World Report ranking of best American universities. We asked students what they valued more: the Ivy League education they were getting, or the Ivy League brand attached to it. 

FEMALE STUDENT: It’s a very difficult question.

We did hear a fair amount of pro-education sentiment.

FEMALE STUDENT: The education here is obviously incredible. I don’t always love Columbia’s brand. I’m more proud of my education than the fact that I’m at Columbia.

MALE STUDENT: I don’t, like, wake up every day and say, “Oh, I’m so excited to engage in this prestigious experience.” I say, “I’m so excited to learn about this particular thing.” So probably education.

FEMALE STUDENT: I think that Columbia does a good job of collecting people who care about knowing things and who care about asking questions, and to be in that kind of environment really does push you. 

But the vast majority of the students we spoke with had a different answer about what mattered most.

MALE STUDENT: The brand value, for sure.

FEMALE STUDENT: You could get the same education, at a not Ivy League school and a not top 50 school.

MALE STUDENT: Especially with like with classes being online, it maybe leans slightly more towards the brand value than the education.

FEMALE STUDENT: The reason why they can justify charging $80K a year is probably the brand name. Whether it’s worth it or not, I don’t know.

MALE STUDENT: I mean, you could get a very good education at most schools in the country. Anyone will give you a very good degree and you’ll learn a bunch, but having that brand name is what makes it worth going to a school like this.

MALE STUDENT: It’s pretty much just like the diploma, to be able to say you went to an Ivy League school.

FEMALE STUDENT: I think you can get an amazing education anywhere. Obviously it’s top-notch here, but it’s the connections you have after college, too.

MALE STUDENT: When you apply to a place, and you have that brand on the top of your C.V. and the network that comes on top of it. There’s a reason why a lot of people can’t get into the school, and it’s so prestigious.

In other words, the education itself is valuable. However, the difficulty of getting into the institution may be MORE valuable. Based on how hard it is to get into the institution, the “prestige” factor can help explain the increase in the value of connections. One more little tidbit that I found really interesting (and again, this is generalized…we’re not saying every tenured or tenure-earning faculty stinks…at least I hope not).

Morty Schapiro, wearing his economist hat and not his college-president hat, has analyzed the impact of faculty skill. He wanted to compare how students did if they had an intro course taught by a tenured or tenure-track professor versus a non-tenure track professor, including an adjunct. Adjuncts are essentially freelancers who get paid much less than tenure-track professors and who are leaned on extensively by even elite colleges to teach a lot of classes. Schapiro found that students who took intro courses with non-tenure track professors did better in more advanced courses than if they’d had a tenured or tenure-track professor for the intro course. One reason tenured professors may not be as good at teaching is that, as we mentioned earlier, the top schools may value research over classroom instruction. Still, if you’re the student or the parent of a student at an elite school, shouldn’t classroom instruction be pretty important? Miguel Urquiola says that reputation and prestige tend to trump the actual quality of instruction.

Wait a minute. The actual instruction is better when you do NOT have tenured professors? Apparently, this is the case. Is it shocking to me? Not really. Because teaching requires someone to be focused on teaching…more so than research and service. This is not to say that research and service are not important (research drives a lot of the grant money). It is also not to say that there aren’t double and triple threats who perform above average in two or three of the categories. There are some real superstars out there! However, on average, teaching is largely about how much effort you want to put into it and, some put in a lot of effort.

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Granted, these are not the major universities. If we look at the top-10 schools (and these will vary depending on which rating program you use — we’re using US News)1 we get the following:

• Princeton University ($56,010 with 4773 undergrads)

• Columbia University ($63,530 with 6170 undergrads)

• Harvard University ($55,587 with 5222 undergrads)

• Massachusetts Intitute of Technology ($55,878 with 4361 undergrads)

• Yale University ($59,950 with 4703 undergrads)

• Stanford University ($56,169 with 6366 undergrads)

• University of Chicago ($60,963 with 6989 undergrads)

• University of Pennsylvania ($61,710 with 9872 undergrads)

• California Institute of Technology ($58,680 with 901 undergrads)

• Duke University ($60,489 with 6717 undergrads)

If we look at just the top three state schools in Kansas2, we get the following

• University of Kansas ($11,166 with 19,135 undergrads)

• Kansas State University ($10,466 with 16,257 undergrads)

• Wichita State University ($8,800 with 12,407 undergrads)

Again, you can see two big differences. One, these program (Kansas State institutions) are much larger. Two, they are much cheaper (about $45,000 per year in sticker price). Cheaper is relative as it is going to vary dramatically from one student to the next depending on grades, department, financial need, and a bunch of other factors. That said, $45,000 per year over 4 years does add up to a chunk of change. .

Let’s also get into what we mean when we talk about averages. There are two commonly-cited numbers for averages. The mean and the median. They are calculated very differently. The mean takes the total student loans and divides by the number of students with debt. The median takes the debt of the 50th percentile. They tell a very different story.

Pew Research found that in 2016, the median borrower with outstanding student loan debt for their own education owed $17,000. Among borrowers with less than a bachelor’s degree — students who went to community college, trade school or dropped out of school before graduation — the median self-reported debt was about $10,000. For borrowers with a bachelor’s degree, the median was $25,000. For the borrowers with postgraduate degrees, the median self-reported student loan debt was $40,000.

Note the highlighted part of the text “with outstanding student loan debt for their own education”. How you define median is critical. Are you using the entire population (there are 331 million people and only 43 million have student loan debt) or are you using a population that is more likely to include recent students (say the total population between 20 - 34…which is 67.67 million). It gets complicated pretty quickly. That doesn’t imply that student loan debt doesn’t count or is irrelevant. It does and is! However, a loan for the equipment to start a lawn service or other small business is not a lot different — they represent investments in tools that are equally important for success. We don’t have 18-year-old’s making the decision to borrow money for opportunities without a clear understanding of their costs and benefits. It also indicates that graduate school adds an extra layer of costs which is often just lumped into “student debt”.

“I Don’t Think the Country Is Turning Away From College.”

In episode 3 (or episode 502 if you’re keeping track of all the episodes), Steve Dubner spends the episode talking to Chris Paxson about her role as President of Brown. One thing that I want to add is that being President of a university is a thankless position. It requires far more effort than I would ever want to spend trying to please students, faculty, staff, donors, politicians, parents, the town, and probably 100 other groups of people. It is impossible to do well (as in make everyone happy). I had the priviledge of working with our long-term President who had more energy in any given day that he gave to the job than I had in a week. Kudos!

Let’s go to a few pieces from the interview.

DUBNER: But since Brown produces knowledge and since knowledge is power, theoretically at least, wouldn’t you want to empower as many people as possible? Are there other routes you could think about expanding the Brown philosophy and education? Maybe not in Providence, but maybe it’s campuses around the country, maybe it’s campuses around the world, maybe it’s a more intense virtual offering. 

PAXSON: Yeah, I don’t think that’s something — where we can really expand knowledge is through our research. And that’s an area where we’ve made a lot of investment. So it’s important to remember that major research universities, their mission is to expand knowledge. They do it through education. They also do it through knowledge-production research.

DUBNER: And of course, what you’re saying politely to me is that the leverage there is much, much, much greater than taking on an extra couple hundred students a year, yes?

So, here we see the emphasis on research above teaching. This is a legitimate debate and one that I think is important. Not everyone is equally gifted at all areas of the “professor” role. Research IS important! Unfortunately, it does not mean a good researcher is a good teacher (or vice versa). There are exceptions, but on average, those who excel at one are more motivated by doing that thing. It may be wise to segregate the roles (something about “Law of Comparative Advantage” maybe?).

PAXSON: I’ll give you two variants of an answer to that question, and one is a little bit flip, but I think there may be something to it. I was meeting with a group of reporters once who were talking about the Ivy this, the Ivy this, Harvard, Yale. And I said, “Hey, where did all of you go to college?” And they all went to Ivies. So, I think there is a little bit of journalists — no offense intended — focusing on the education that they experienced. I also do think, though, that there’s something about increasing income inequality in America, that is driving attention on the places that are really seen as being the golden tickets to not just prosperity, but to really high-end prosperity. One thing we know is that the very most selective colleges and universities are very good at propelling people into the top 1 percent of the income distribution. 

DUBNER: And when you say “propelling” — can you give evidence that this is actually causal?

PAXSON: I knew you were going to ask me that as soon as I used the word “propelling.” Among the people who go to these elite schools, a very large fraction of them end up in the top 1 percent. I don’t know how much that is causal. I think a lot of it probably is. And especially the low-income students who end up coming to a place like Brown, who wind up having wildly successful careers, it’s hard for me to imagine that that would have happened if they’d gone to their local community college.

This is one of the things that, while I understand — remember that college presidents have lots of constituencies — I disagree with. The purpose of the university is to provide a transformative experience to all the people who work at the university. That does include the researchers. However, it also includes the students, the teachers, the staff, and lots of other people. Chris Paxson, likely is overselling the ability of Brown to “propel” students forward. I think she provides them with an opportunity that they probably wouldn’t have gotten (this is very good), but it undersells the assets that THOSE STUDENTS bring to the table. These students are likely overachievers (in a big way) that would be successful at any institution of higher learning. Does it create connections? Sure…review the “prestige” factor discussion raised earlier. However, I’m guessing that these same students would have found opportunities to be successful anywhere that they went.

Next came a question on endowments and, while Paxson is being honest, there is a lot of wiggle room in the answer she gives. Last year, Brown earned a 51% return (granted, there were a lot of high return investments in 2021) and I’m guessing the rate of return is trending a bit lower in 2022. However, it is still a staggering return.

The gains came over the course of FY21, which began July 1, 2020 and concluded June 30, 2021.

The 40.8% growth of the S&P 500 Index over FY21 indicates the strong performances of industries across the board.

This line of questioning closes with the following exchange:

DUBNER: But saying that there are confidentiality clauses — as I’m sure there are in many, many, many investment ecosystems — doesn’t it make it sound a little bit more like there’s this cabal of elite universities with billions of dollars who have ways of making even more money than all the rest of us don’t have access to? Are you concerned about that perception?

PAXSON: Well, I think that we’re trying to do what we can to advance our mission the best way possible. 

Not exactly a shining moment.

Here is another line that might have escaped attention…but is actually a bigger issue within the field of academia (from Paxson).

My grandfather taught at the University of Tennessee. He went there as a student, and he could not have done what he did in his life if he hadn’t found his way there.

Here is an important finding from a research article by The University of Colorado (https://osf.io/preprints/socarxiv/6wjxc)

If your aspiration is to become a university faculty member some day, here’s a bit of advice: choose your parents wisely. Turns out that university faculty are, on average, 25 times more likely to have had a parent with a PhD than the general population. In addition, those faculty tended to grow up in neighborhoods that had a 24% higher median income than the general public.

Dang, I missed the boat there as neither of my parents completed a PhD! However, there is a lot of work being done here by creating an environment where education is seen as important and the benefits of an academic job are understood. Granted, having a parent that grew up teaching about economics is going to enhance your knowledge of what the job is like and your aptitude to pursue it. This is no different than the NBA (https://www.espn.com/espn/story/_/id/6777581/importance-athlete-background-making-nba). However, it does stress the importance of family connections. Never undersell how important connections are to your career!

Going back to the cost issue, the topic of “what does someone pay?” came up

DUBNER: It’s hard, though, because the net price is not published, is it?

PAXSON: Actually, it is. The Department of Education requires that we have net price calculators on our websites. You can go in, you can put in your income level, your family characteristics, and it can give you an estimate of what it will cost to go to that school. 

DUBNER: The net-price calculator is for you, as an individual family. But if I want to know the average net price for a given university, I can’t find that, can I? 

PAXSON: Oh, that I don’t know. You could do it. It would take a long time.

Notice that the answer here is intentionally vague. There is talk that the student support for going to school for state students has gone down significantly, but little on the cost situation for private schools like Brown. How much does it cost to go to Brown? Your guess is as good as mine because there are multiple factors that go into determining the net price.

DUBNER: Can you talk for a minute about what you economists call “cost disease” — the idea that in certain fields, wages rise much faster than productivity, and this would certainly apply in higher ed — maybe in all education. I wonder how much that is responsible for tuition inflation?

PAXSON: Ah. So, one of the arguments is that we haven’t seen the same amount of technological change in higher education. By and large, it’s still one faculty member in one classroom with a whole bunch of students, and what that’s going to do is drive prices up in higher education. We’re not seeing the same type of technological change that other industries are seeing. Now, it’s interesting because Covid has forced us all online. And for years, I heard from people who would say, “Look, put everything you do online, you can deliver the same quality of education. You can charge a tenth the price. Why aren’t you offering college degrees for $5,000?” Usually when I hear that from an alum, I say, “Would you send your child to school that way?” And the answer is no.

DUBNER: “Because I don’t want them in my basement.”

PAXSON: “I don’t want them in my basement, in their pajamas, pretending that they’re going to school when they’re really playing video games.” No. What we learned in Covid was, actually we can impart knowledge well virtually. But that’s not the kind of experience students or faculty want, and the social aspects of being in school — and when I say social, I don’t just mean fun, I mean the interactions between faculty and students, between students with each other as they learn — that’s a really important part of college. I do think that the experience with online learning has been better in graduate programs, professional programs, more targeted skill-based programs. Can you learn how to code online? Yes, you can. There’s more we can do with new technology, but I’ve become persuaded that the model that we have probably won’t change wholesale in the coming years.

This is one of the issues that I think is essential in college education. You (and by “you” I mean the entire university — faculty, staff, students, etc.) are taking young adults (18-year-olds) and teaching them move closer to actual adults. Learning, especially when you are in the 18-22 age group comes with bumps and bruises. However, having faculty, support staff, students that are willing to work together is an essential part of the college experience. Students that work together, goof around together, discuss the importance of grades, going to football/basketball games, attending a college comedy night bond together. Working on completing three projects that professors decided to make due on the same day (it happens) while balancing work study or job demands can present different challenges in time management skills (one of the factors students often mentioned with my classes). Leading a club meeting or being involved in student government while trying to figure out how you’re going to make the $4.00 food budget last (which may be because you spent $40 on drinks/snacks over the weekend) is another example of this dilemna. I would argue that most students struggled with these issues (which is a great way of learning to deal with life challenges).

The key is that students will make lifetime friends in classes. They’ll do REALLY stupid stuff and they’ll do REALLY smart stuff. Some will meet their future spouse. This will come with jerks for professors (ask any college student and they’ll have some horror stories to share — feel free to comment and share your stories) and with faculty (maybe even non-tenure track) who provided the push to get them across the finish line.

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There was a time that I thought online education would be a reasonable solution. It is, but only for the right students. If you are self-motivated it can work (although, if you are TRULY self-motivated, you can probably design your own program). Unfortunately, if you are not self-motivated it can get ugly…really quickly. Assignments get skipped and students lose their motivation. It becomes a milestone to complete, instead of a learning process to celebrate. Most importantly, student/faculty and student/student engagement drops…often dramatically.

Solutions To Better College

One question that often comes up in a podcast is the host asking the guest what two or three things would they do to improve the situation being discussed. In this case, I’m playing both roles — the host AND the guest. So let me address the three things that I would recommend to improve the college experience. However, the disclaimer is that this is one person’s opinion. Which means that this might be a good discussion over a nice Diet Mountain Dew because there isn’t a “right” answer.

Cost and Administrative Bloat

Figure out a better way to structure the cost issue. And no, I don’t have a solution here other than the last 50 years shows that the college cost structure doesn’t work. A big part of this has to do with regulation and oversight. The term administrative bloat has come to be a part of campus discussion, with good reason.

Whether it qualifies as bloat or not, the overall cost of college administration has gone up dramatically in direct proportion to the decades-long upward trend in college tuition. An article from the American Council of Trustees and Alumni (ACTA) reports that, across the entire higher education landscape, spending on administration per student increased by 61% between 1993 and 2007.

It should be noted that I started my teaching career in 1995, so was right in this slipstream. I would guess that the number may have actually increased since 2007, but don’t have the data to back it up. That said, the administrative positions have increased dramatically. This means faculty are spending more time with non-teaching functions, leaving less time for actual teaching and interacting with students. It also means that there are more administators overseeing the faculty.

This may come with eliminating student loans (or reducing them), making college costs more visible and direct (for example, eliminating the “if you make under $125,000 you don’t pay anything to come to Brown”), etc.

One thing that I am not in favor of is the split between the 2-year college and the 4-year college. They both have a function, but the idea of the 2-year college being a feeder program for the last 2-years at a 4-year school is less than ideal. I would argue that it actually is a deterrent to the success of a college student (again, not for every one, but on average) because you are transitioning to specific coursework, meeting new people (which is good, but is a lot harder when your the new guy/gal), getting used to a new system (such as learning management systems), etc. Transitioning to a new school and settling in is a bigger struggle than most realize. It also creates challenges for the university in making sure students take the right prerequisite courses.

Split Colleges Into Teaching vs. Research

Again, I don’t have the solution. However, there are people who are outstanding researchers (and terrible teachers). There are people who are outstanding teachers (and terrible researchers). Being good at one does not imply that you are good at the other.

This is perfectly reasonable. People have different skill sets and interests, so let them specialize. I was a much better teacher. My skill set was taking complicated stuff and making it relatively simple (well, as simple as something like the Black-Scholes Option Pricing Model, Duration, Investing 101, etc. could be). I could also bridge connections and discuss things like false precision, human biases, and other “big-picture” concepts into a topic like estimating the Weighted Average Cost of Capital. On the other hand, my research skills were lacking and my service was relatively strong. I was more of a double-threat, but teaching was clearly my strength. That did not make me more valuable than a good researcher (we’ll let the markets figure that out), but it did mean that my time was better spent towards teaching.

Eliminate K-12 Integration

This is something that I think is important and often overlooked. We have splits in the educational system. There is grade school (typically grades K-6), middle school (grades 7-9), and high school (grades 10-12). Those vary depending on area (you might have K-5, 6-8, and 9-12), but typically it is along those lines. There is a reason for this as what you learn in each segment is going to vary a bit.

However, we then go into “higher” education and it seems that there has been more of a carry over into “the way students learn.” When I taught Business Finance and Investments courses, they were designed to do two things. One was to teach the basics of business finance and investments (how to calculate time value of money, what is the weighted average cost of capital, how do we value a stock vs. a bond vs. a derivative, etc.) and the second was to teach them to think. Of the two, I was much more concerned with the latter. In my business finance class, there were typically 10-20% (20% would be the high end) of students pursuing a finance major. The chances that they would be calculating the NPV of a project was relatively low (and it would’ve been wrong anyway…it is an impossible thing to forecast with any degree of accuracy).

However, having an understanding of WHY the NPV was better than the IRR, how you calculate taxes on investment income, why people tend to be overoptimistic with how quickly they will get things done, etc. are far more important. These are not the things you put on the syllabus. They ARE the things that differentiate who will have successful lives — regardless of what career path they choose.

Having a project with a rubric taught students how to fulfill a project following a precise path. Having a project without a rubric, teaches students how to fulfill a project following their own path. I was ALWAYS more interested in the latter because that is where personal success lies. This meant a lot more time interacting with students to answer questions. I wanted them to get stuck and ask for additional help because that allowed me to guide them. Also, and this is only surprising to people who don’t teach, I learned a ton from their questions. I learned how to better answer their questions. I learned that there are often multiple approaches students can take. I learned that their solutions were sometimes better than mine. Student-teacher and student-student interactions are an incredible aspect of the learning process and it can easily get lost in a rubric where you are grading technical aspects rather than the project as a whole.