Ro Ro Farm Co.
Investment Partnership
2019 Letters To Partners
OVERVIEW OF THE ECONOMY
To start, we are not in the business of making macro-economic forecasts. Nor are we in the business of predicting the trends of markets. We invest in or derivative of income-producing assets. We use four filters 1) competitive advantage, 2) price-to-value, 3) shareholder-oriented management, and 4) an investment that is within our circle of competence.
We have a favorable view, especially for American businesses and the economy. For instance, if you look back just 50 years ago and compare it to 2019, peoples’ standards of living are much higher. Further, with productivity growth, development in technology, and the medical industry, the standard of living will most likely be higher in the future. However, we will have hiccups, periods where the economy goes through a recession.
In 2019, the aggregate supply (potential) side of the economy grew roughly about 2% for the US economy. In the 1990s and early 2000s, we can strongly argue the aggregate supply grew roughly about 3% per year. The 2% could be broken down into 1.5% for an annual increase in worker productivity plus another 0.5% for labor force growth. Now, to get an idea of the economy, we must look at aggregate demand, which Is the actual economic output (GDP). GDP consists of consumption of goods and services (69%), business investment (18%), government spending (17%), and net exports (exports – imports, -5%). In 2019, GDP grew 2% to 3%. Given that aggregate demand is consistent or higher than aggregate supply; thus, the economy is in good shape.
Over time, if the aggregate supply is higher than aggregate demand, then the economy has an output gap, where the economy can fall into a recessionary period. If aggregate demand is in line with aggregate supply, then we reach a period that is known as full employment. However, aggregate demand is higher than aggregate supply, which can lead to an increase in prices (inflation). Note that inflation can also be affected by the FED, which is an entirely different topic. In 2019, inflation had an increasing trend, which increased from about 1.5% to 2.3%. In 2019, we can argue that actual output increased to pass the full employment level of output. This creates shortages of available labor, and other commodities are driving up production costs that are passed on to the consumer as higher prices. The unemployment level reached its lowest level in 2019 of 3.5%.
High inflation can be unhealthy for the economy because the buying power of the dollar decreases. When the inflation rate rises to an unacceptable level, the FED puts the brakes on the economy by increasing interest rates. This causes the economy to slow down. In 2019, the interest rate (federal funds rate) decreased from 2.5% to 1.75%. The FED tries to be proactive than reactive.
Some other exciting things to consider are 1) the increasing trend in business bankruptcies, 2) the increase in Central Banks Balance Sheet. Overall, the economy is healthy; however, that was 2019. Let’s see what happens in 2020.
OVERVIEW OF THE MARKETS
In terms of the markets, the S&P 500 (500 largest publicly traded companies in the US) increased by 28.88%. Since 2008, the price to earnings ratio of the S&P 500 reached its highest level of 25.04. We look at overall valuation relative to interest rates. Currently, the interest rates are still very low; thus, we don’t think that the market (not making judgments on other markets) is in bubble territory, but it is in the range of high valuations. However, we do think that there are some undervalued companies relative to low-interest rates.
Note that the economic variables and the market variables don’t move in a synchronized fashion. Thus, we don’t predict the economy or the markets because it is equivalent to predicting the action of a mob in a football game.
NOTE ON THE POWER OF COMPOUNDING ON PRODUCTIVE VS NON-PRODUCTIVE ASSETS
In 1942, if you had the option to invest $10,000 in the S&P 500 index (reinvesting the dividends) and $10,000 in gold, then you would have $65 million in S&P 500 index and $490,000 in gold. The only judgment you had to make is to have the assurance America would do fine over time and invest in the S&P 500 index. Now, if your attitude were negative, thus you invested in non-income producing assets, gold, then you would have the same amount (about 300 ounces of gold). However, the opportunity cost of investing in gold is $64,510,000. Ouch!
RO RO FARM CO
In 2019, our investment partnership had an annualized gain of 40.15%. Our gain was caused by our daily bread and butter operation of using our four filters in income-producing assets given a long-term horizon. Note, we do use a quantitative and qualitative approach. Further, we also have a highly concentrated portfolio. We have six companies in our holdings (excluding holdings that we are currently exiting). All six holdings are highly concentrated (10%+ of the portfolio) and are undervalued, given our valuation metric. Now going onwards to 2020, I can’t promise you that the performance will be of the same nature. However, we will continue to operate in the same manner as we have served in 2018 and 2019.
Cordially,
Rojan Shrestha
General Partner