Show me the incentive and I’ll show you the outcome.

—Charlie Munger

 

Investing is about understanding human behaviour. The more you can predict how people will act, especially in herds, the more of an advantage you will have.

I like to think of incentives as ‘bread’ in the old German proverb: ‘Whose bread I eat, his song I sing.’

‘Bread’ means anything really of value. Sustaining relationships. Supernormal profits. Power and prestige.

 

Hinkel Bakery, Düsseldorf. Source: Ted McGrath / Flickr

 

Sometimes these incentives lead to perverse outcomes.

How often have we seen people sacrifice integrity for the sake of belonging?

During the Covid response, very few stood up for those who suffered at the cruel end of government policy. Most wanted to just go along.

When a herd attacks a good man because his beliefs do not match the liberal line, it’s far easier to go along to get along. Most people’s standard responses are:

  • ‘Protect the bread so I can survive.’
  • ‘Go where there is more bread.’
  • ‘Toe the line of those who supply the bread.’

Of course, for those willing to risk a different path, there may be a lot more bread.

 

Think big and discover better incentives

 

This dynamic — of unseen incentives quietly shaping outcomes — became especially clear to one businessman in the 1980s.

He had just caught a news report on the radio.

The stock price of Hilton Hotels dropped suddenly following a strike in Las Vegas, where they had two hotels.

He was stunned. He asked himself:

‘How was it possible that the stock of a company that owed at least a hundred hotels worldwide could be hurt so badly by a strike against just two of them?’

When he got back to his office, it took only a small amount of research to find the answer:

‘Hilton, it turned out, owned more than 150 hotels worldwide, but its two casino hotels in Las Vegas accounted for nearly 40 percent of the company’s net profits.

‘By comparison, a hotel such as the New York Hilton… accounted for less than 1 percent of overall Hilton profits.’

 

The businessman was Donald Trump.

Thinking big and discovering better incentives prompted him to expand beyond his usual stomping ground of New York City.

 

Trump Plaza Hotel and Casino, Atlantic City, New Jersey. Source: William Warby / Flickr

 

The story does not finish there.

While Trump Plaza became one of the most successful in the area during the 1980s, it lasted barely 30 years.

It fell into disrepair and closed in 2014. It was demolished in 2021.

There is perhaps a further lesson in this. A good incentive in a troublesome industry may not last the distance.

But an unnoticed incentive in a very good industry could provide an investing sweet spot: a cheap entry into a great business you may want to hold forever.

 

Unnoticed incentives in great businesses

 

My job is to find and invest in great businesses that the market has not already priced to perfection. And unlike the casino churn of Atlantic City, businesses that can stand the test of time.

Given the tax treatment on global shares here in New Zealand, we’re also looking for businesses that pay great income. In fact, we’re looking for certain key characteristics:

  • Quality assets that can be defensive in times of volatility.
  • Good dividend yields from excess cash flow.
  • A cheaper stock price due to the market cycle or patches of undue fear.
  • A business showing good compounding growth — earnings momentum that builds like clockwork.
  • Very strong return on the capital employed.

This means I’m not going to pick highly speculative stocks that will shoot to the moon or collapse. It means risk-managed opportunity available at value.

When there’s no value available, we just sit on our hands.

The best way to get rich is slowly.

That may not be a wildly exciting concept, but that’s where the very best incentives build.

 

Quantum Wealth Report

 

 

Every week, we explore market trends and develop our investment thinking in our premium news.

Incentives shape markets, and markets reward those who see what others miss.

That’s what we explore each week in our Quantum Wealth Report — hunting the hidden bread the herd overlooks.

If you’d like to get more Wealth Morning, I encourage you to take a look.

 

 

Regards,

Simon Angelo

Editor, Wealth Morning

(This article is the author’s personal opinion and commentary only. It is general in nature and should not be construed as any financial or investment advice. Please contact a licensed Financial Advice Provider to discuss your personal situation. Wealth Morning offers Managed Account Services for Wholesale or Eligible investors as defined in the Financial Markets Conduct Act 2013.)