Energy and returns
How does energy relate to investment returns? Substantially.
Economics operate on energy transfer. I do work for you. My energy is expended for your benefit. For a fee! Or, electricity is generated from my solar panels. It is sent to the grid, used by you to light your home. Every economic act is a transfer of energy, but it goes far beyond just economics. Humans and animals alike survive on the conversion of energy.
When I was running money at KIS Capital Partners, our investment strategy was active. Not high frequency active but we could turn over the entire funds’ assets in 2 weeks. So, at our peak, that's $150,000,000 per week. The idea of being that active is to make your returns from activity in the market, not necessarily from the performance of the companies and their management teams.
Trading catalysts and anticipating which way other investors will move a stock price is the common goal of this strategy. A company might have a new product launching, a regulatory change, earnings news, sell side research coverage, etc. The list is long. This strategy requires an enormous amount of brainpower, time and energy, to make so many decisions consistently over a period of time to generate a respectable return. The average return on each trade was measured in the plus or minus 20% range with obvious outliers over time.
As I ponder KIS 2.0, it occurs to me that whilst our headline returns at KIS were very respectable, the energy to return ratio in retrospect was anything but. 'I NEED to be on the desk for the open' was standard operating procedure. The phone must be answered 24/7 in case there is 'something to do'. This meant less time to deeply think. Less time seeking out great companies and management teams. It meant less freedom and less serendipity to find the next great idea.
Contrast this energy to return ratio to another investment. I have invested in multiple private companies over the years. When doing that, you spend most of the energy for that decision upfront and given there is generally little liquidity, you don't really have to or can't make another decision for many years after. The return on those investments is measured in multiples of your initial investment, with some being zero of course. However, you can read in this book 100 Baggers: Stocks that Return 100-1 and how to find them that this type of performance outcome is not limited to private and unlisted investments. They can be found on the stock market too.
The energy to return ratio is significantly better and it is obvious. But what has actually happened? There is still an economic outcome so where did the energy come from? The energy to create the economic return has come from the management and employees of that company and not from you moving around their shares in the stock market.
You can put a number on the ratio if you like but this is more concept than math. I have done it here however:
Energy spent expressed as a number between 0 and 10. 0 being no energy and 10 being an enormous amount of energy. The return being the percentage return on your investment. 1% or 1000%? If you divide your return by the energy exerted, you get a number. The higher the better. Of course, how long this return takes to crystalize is also important. Divide that again by the time, let’s say per month. An energy score of 1 with a 1000% return gives you a 10. Divide that by 12 months and we get 0.83. An energy score of 9 and a return of 10% gives you a 0.01. Did that in 2 weeks? Your score is 0.02.
How can we be more energy efficient in our investment process and also give that energy massive leverage? Possibly by finding management teams that you can stick with for a long time that compound your return on energy.
