Tuesday, May 28, 2019

Bad Blood

I recently read "Bad Blood" a 2018 book by John Carreyrou.  This book tells the story of Elizabeth Holmes and her startup company, Theranos.  Holmes was an undergraduate at Stanford University when she came up with the idea of founding a company based on revolutionary new technology that would allow many medical tests to be performed using a single drop of the patient's blood. Unfortunately Holmes didn't actually have such technology or it appears a realistic plan for developing it.  Holmes wasn't deterred by this, she dropped out of Stanford in 2003 and raised millions in venture capital for Theranos.  For a while Theranos seemed quite successful.  At its peak in 2013 and 2014 it appeared to be worth around $10 billion which would have made Holmes a multibillionaire.  However this valuation turned out to be illusory.

John Carreyrou was (and is) a Wall Street Journal (WSJ) reporter. He wrote a series of articles for the WSJ starting in October 2015 about wrongdoing at Theranos which broke the spell Holmes had cast.  Other investigations by government regulators followed and it soon became clear that the vaunted Theranos technology had little if any real value.  Theranos ceased operations in 2018. Holmes has settled civil charges with the SEC and is currently awaiting trial on criminal fraud charges.  This book tells the story through 2018.

I was a bit disappointed in this book.  Much of it consists of the stories of various Theranos employees who were made uneasy by some aspects of the way Theranos did business.  This gets repetitive after a while. The book seems longer than necessary at about 300 pages.  And it doesn't seem particularly insightful about pulling together the facts that Carreyrou uncovered.  

The book isn't totally worthless, I did get from it a better picture of what happened.  However perhaps the story is ultimately not so significant or interesting that it needed a 300 page book, at least not this one.  I think most readers can safely skip this one.

Thursday, May 9, 2019

Railroader

I recently read "Railroader" a 2018 biography of Ewing Hunter Harrison III by Howard Green.  Harrison (who went by Hunter or E. Hunter) lived from 1944 to 2017.  He worked for railroads most of his adult life starting out as a laborer (carman-oiler) in 1963 and eventually becoming the chief executive officer (CEO) of four different major North American railroads.  He made major changes that were very successful (at least from a shareholder point of view) and which have reshaped the industry.  Comparable in some ways to Steve Jobs, Harrison is much less well known (as indicated by the respective sizes of their wikipedia entries linked above).

A key measure of profitability in the railroad industry is the operating ratio which is defined to be the ratio of operating expenses to revenue.  Clearly lower is better.  Harrison made his reputation by significantly lowering the operating ratio at each of the railroads (Illinois Central, Canadian National (CNI), Canadian Pacific (CP) and CSX(CSX)) where he worked at the executive level. This led more or less directly to increased profits.  In many industries such increased profits would be temporary as competition means lower production costs are eventually passed on to customers in the form of lower prices.  However there is little price competition among the major railroads (they do compete on price with the trucking industry) so this process is occurring slowly if at all.  The result is much higher stock prices and happy shareholders. Certainly I am happy that my Norfolk Southern (NSC) stock is up about 120% (as compared to about 40% for the market as a whole) since I bought it in 2015.  Harrison didn't work for NSC but shareholder pressure is forcing the other major railroads to adopt his methods.

While Harrison made his shareholders happy other stakeholders such as employees and customers were less pleased.  If you browse the forums where railroad people hang out you will find a lot of animosity towards Harrison.  This is natural as some of the shareholder gains came at the expense of employees.  Many workers at all levels lost their jobs either because Harrison determined that they weren't really needed or because they were unwilling or unable to adapt to the new order.  No one likes to lose their job and there is a natural wish to believe (however delusionally) that the company will come to regret eliminating it.

Some customers too were unhappy with the changes.  In some cases because they were made worse off even if overall the changes were beneficial.  In other cases because the changes were disruptive short term regardless of any long term benefits. Harrison's take or leave it negotiating style and in some cases the lack of reasonable alternatives didn't help. Customer dissatisfaction appears to have been particularly acute with CSX the last company Harrison managed because Harrison seems to have tried to make changes too rapidly leading to frustrating service disruptions.  Harrison's haste is somewhat understandable as he died less than a year after starting at CSX and must have suspected he didn't have much time.  However it was enough as he was succeeded by a disciple, James Foote, who has largely followed the course Harrison set.

So what was Harrison's secret.  How was he able to repeatedly achieve outstanding results.  One important factor has been alluded to above.  The railroad industry is very old and over time arrangements had evolved that balanced the interests of employees, shareholders and customers in a certain way. Harrison realized that this balance was not set in stone.  A balance more favorable to shareholders was possible.  For example just because it had become customary to allow some employees to leave early (before the end of their shift) didn't mean Harrison had to go along.  If he required employees to work their full shifts he could get by with fewer of them.  There seems to have been a fair amount of fat of this sort that Harrison could eliminate if he was willing to unilaterally alter longstanding arrangements.  Similarly in some cases Harrison could raise prices or otherwise change customer contracts to the railroad's advantage.

Another thing Harrison did was emphasize the efficient use of capital equipment.  This is important in a capital intensive industry like railroads.  Harrison realized that locomotives and rail cars were only earning money for the railroad when they were in motion.  So he tried to keep them in motion.  If he operated his locomotives more hours per day he could get by with fewer of them.  Similarly if he reduced the time rail cars sat around in yards waiting for the train that would take them on the next leg of their journey to be assembled and dispatched he (or his customers who in many cases own the cars) could get by with fewer of them and also improve service by reducing transit times.

Harrison also introduced what has become known as precision scheduled railroading (or PSR).  This involved two changes. Freight railroads had traditionally not operated on set schedules instead dispatching trains once a sufficient number of cars had been assembled.  This meant customers could never be sure exactly when their shipment would arrive.  Harrison moved towards fixed schedules in which trains left at set times.

The railroads had also used a hub and spoke system in which a rail car would start at a spoke location pass though one or more hub locations and finally end up at another spoke location.  This involved a lot of assembling and disassembling of trains as cars would be brought together for one leg of their journey and then go their separate ways on the next leg.  This work was done at hump yards so named because they were built on an incline (or hump) to allow gravity to help move the cars around.  These yards tended to be expensive bottlenecks which slowed the movement of cars through the system.  Harrison moved towards a point to point system in which trains moved cars directly from their origin to their destination.  This allowed the closure of many hump yards. The net effect of these changes is theoretically to reduce costs while improving service by making it faster and more reliable.  In practice the cost savings from PSR seem to be clear cut but the service improvements have been a bit more debatable particularly in the transition stage while kinks are being ironed out.

Over the years Harrison had a lot of detractors but for the moment at least he seems to have prevailed.  The railroads he managed have for the most part continued on the new course he set and the remaining large North American railroads are adopting his methods, the financial results he achieved are just too impressive to ignore.  During their latest quarterly report conference calls NSC talked about hiring people with PSR experience and Union Pacific (UNP) said it was going to "pause" construction of Brazos Yard, a large new hump yard it had started constructing just last year with considerable accompanying fanfare.  The other large American railroad BNSF (Burlington Northern Santa Fe) doesn't directly report to public shareholders as it is now part of Warren Buffett's Berkshire Hathaway conglomerate.  Buffett has said that he tolerates a certain amount of fat in the companies Berkshire owns so there is less pressure on BNSF to rapidly adopt Harrison's methods.  Still it seems unlikely that Buffett will accept substantial underperformance indefinitely.

Regarding the book, Howard Green is a television journalist who interviewed Harrison several times. Apparently they got along reasonably well so Harrison commissioned Green to write his biography.  It was to be unauthorized in the sense that Green was to have the final word on content and in any case Harrison (who had been seriously ill for some time but continued to work) died before the book was finished.  Still Harrison probably expected the book to be generally friendly towards its subject and it is.      

The strength of the biography is Green's access to Harrison, his family and his friends.  This led to hundreds of hours of interviews many with Harrison himself.  However Green perhaps relies too much on stories told by or about Harrison in interviews.  While these stories do give an impression of what the man was like there is often room to doubt that they are completely accurate.  In several cases Green notes that other people's accounts of the same events differed.  However in other cases Green seems to have made little effort to establish what actually happened.  One disadvantage of becoming friendly with your subject (and his family and friends) is that it may make you hesitate to ask questions that they might find disagreeable.  For example Harrison's father apparently suffered some sort of injury while serving in the armed forces during WWII. The book is extremely vague about exactly this was.  I expect the relevant military records still exist but perhaps Green was reluctant to ask Harrison to request them.  Similarly Harrison was seriously ill while working at CSX and ended up dying just a few days after finally going on medical leave.  But again the book is vague about exactly what was wrong.  It appears Harrison was not very forthcoming and Green was unwilling to press him. CSX was also kept in the dark and as a result changed its bylaws to require future CEO's to be regularly examined by a company doctor.  

Harrison retired somewhat unwillingly from CNI at age 65.  He didn't enjoy not working and eventually teamed up with a couple of hedge funds to get himself installed as CEO first at CP and then still looking for new worlds to conquer at CSX.  Naturally the incumbent CEOs (and his previous employers) were not too enthusiastic about this so a certain amount of maneuvering involving proxy fights and lawsuits was involved. This was covered in a bit more detail I would have preferred as I was more interested in what he did as CEO.  

I thought the book was a little weak in analyzing the relative contribution of the changes Harrison made to the improved financial performance.  For example the book discusses numerous changes Harrison made to improve the operating ratio by cutting costs.  But of course the operating ratio can also be improved by increasing revenue through higher prices or volume.  The book says little about this.  Perhaps this is because the contribution of revenue increases was insignificant but if so it would nice if this was explicitly stated.  

It is also unclear to me to what extent the benefits of Harrison's changes extend beyond railroad shareholders to society at large. Harrison claimed his changes would improve service and allow the railroads to take market share from the trucking industry.  Was he correct?  The book isn't much help in answering this question, perhaps interviews with a few large rail customers or trucking competitors might have shed some light.  Regarding future competition between trains and trucks, trains are more energy efficient and will have a competitive advantage if oil prices increase significantly.  On the other hand self driving technology would help trucks more than trains as driver costs are more important for trucks.   

In summary I thought the book was okay.  It was reasonably entertaining and I learned some things from it. However when I saw the book in my local library I checked it out because I already knew a little about Harrison and the changes he has brought to the railroad industry and was interested in learning more.  If you have no such desire you probably won't find this book to be of much interest.

Friday, May 3, 2019

LED Light Bulbs

Although I was vaguely aware that the LED light bulbs have been dropping in price I was still a bit startled recently when I saw a package of 4 60 watt equivalent (9 actual watts producing 800 lumens) LED light bulbs on sale for $2.88 at my local Walmart. This low price was due in part to a rebate program sponsored by the state of New Jersey.  Other local stores like Home Depot and Smith's Ace Hardware (but apparently not Target for some reason) are also participating in this program but the savings are not as dramatic.

I picked some up and installed them in my basement where some of the ceiling bulbs were burned out or missing.  In theory this shouldn't save much because I rarely use my basement but in actual practice I sometimes accidentally leave the lights on (several bulbs are controlled by a single switch at the top of the stairs) and then don't notice for an extended period of time. I recently did this and it appears to have raised my latest electric bill by about $20 (implying several bulbs were on for several weeks).  So there is a potential savings especially if I replace the still working incandescent bulbs also.

It appears that CFL (compact fluorescent) bulbs are now obsolete. The newer LED bulbs are superior in a number of ways.  They are a bit more efficient, age better, light immediately, don't contain mercury and now appear to be cheaper.  It is interesting (and a little sad) how brief (perhaps 10 years or so) the period of dominance of CFL bulbs was.  I still have a bunch of them (and will for a while as they last for a long time) but can't remember when I last bought one.  I doubt I will ever buy another.  I have bought incandescent bulbs fairly recently (and may continue to do so) because I have a couple of fixtures which seem to require them. One is on a dimmer switch which causes LED (or CFL) bulbs to flicker or buzz in a very annoying way.  Another is a decorative outdoor fixture.  It seems like it should be possible to use LED bulbs in it but when I tried some they didn't work for some reason.

Saturday, April 20, 2019

2018 Income Taxes

I mailed in my 2018 US and NJ income tax returns last Friday, a whole 3 days before the Monday deadline. They had been more or less done for several weeks but because I owed money this year I didn't feel any great urgency to complete the process.  However on the preceding Tuesday my phone and internet went out with Verizon giving a repair estimate of the following Tuesday.  The lack of internet left me with time on my hands which I used to get the returns done a little early.  It also meant I couldn't submit them electronically and had to mail them but I am inclined to do that anyway when I owe money because I am a little nervous about allowing them to pull money from my bank account.

I owed money primarily because I had a large involuntary capital gain (from CVS buying Aetna) last year and I hadn't increased my estimated taxes by quite enough to cover the additional capital gains tax.  The lower federal withholding rates also contributed but the new law did provide me a tax cut.  I ran my 2018 income though the 2017 program and discovered my federal tax was about 6.5% less because of the new law.  Similarly running my 2017 income through the 2018 program showed my 2017 federal tax would have been about 9% less if the new law had taken effect a year earlier.  In both cases the general pattern was the same, my ordinary income tax and the net investment income (or Obama care) tax went up because of the new limit on deducting state and local taxes but I still saved money because I no longer had to pay the Alternative Minimum Tax (AMT).  The AMT doesn't allow deductions for state and local taxes so I hadn't been benefiting from those deductions for some time.

I didn't have any particular issues with Turbo Tax Deluxe which I used again this year perhaps because I am getting use to its annoying features.  It still tries sell you upgrades but they aren't really needed.  

Wednesday, April 17, 2019

Norm Thompson RIP


Norm Thompson is a mail order clothing brand which is being discontinued.  Apparently their parent company Bluestem Group announced this back on January 31, 2019 but I didn't get the word until a few days ago when I received in the mail their "Final Sale" catalog.  I was a bit sad to learn they were closing because I have been wearing their "Shikari" shirts for many years.  Judging by old photos my mother started giving them to me in 2003. I like shirts with front pockets to help hold some of the junk I carry around and the Shikari shirts have two so they quickly became my favorite shirt.  Although I continued wearing other shirts for some time as my mother was only giving me a few shirts a year.  In fact I was a little surprised to find a photo of me wearing a different shirt as late as 2013.  However in recently years I have worn the Shikari shirts almost exclusively.      

Norm Thompson mostly sold women's clothing but they did have a small men's section in their catalogs. Some of their offerings are being picked up by Appleseed's, a Bluestem brand which sells women's clothing exclusively.  Perhaps another Bluestem brand which sells men's clothes (such as Blair or Haband) will pick up the Shikari shirts.  If not I do have about 40 of them at this point which is enough to last me for some time.

The photo was taken July 2007 in a sleeper compartment on an Amtrak train in Florida.  Around the time the train ran into a flatbed truck someone had managed to get hung up on the rails at a grade crossing.  Fortunately no one was seriously injured but we had to finish our trip by bus.  It shows me wearing a short sleeved (there is also a long sleeved version) Shikari shirt.

Saturday, April 6, 2019

Phishing

I sometimes receive emails pretending to be from a legitimate business such as a bank trying to get me to divulge sensitive information such as account numbers or passwords.  This fraudulent practice is called "phishing".  Such emails are easy to recognize when they purport to be from a business that you do not have a relationship with.  However if you are sending out millions of such emails you don't need a high response rate.  You just need to get lucky a few times with recipients who for one reason or another find the email plausible enough to get past their guard.

This happened to me.  I have a corporate credit card with American Express which I rarely use but had recently used on a business trip.  I had also recently filled out an online form with a financial institution which has moved to a mandatory 2-factor authentication system.  So when I received an email purportedly from American Express (similar to this) asking me to update my authentication information I accepted it as genuine without much thought. 

It is a well known psychological phenomenon that people prefer to incorporate new information into an existing world view rather than rather than use it to overturn previous beliefs.  So once I had accepted the email as genuine I didn't revisit this question as I filled out the attached form despite some in hindsight red flags.  Even when the form asked for my email password (which I refused to provide) I didn't question that the email was genuine believing instead that American Express was being unreasonably nosy.  It wasn't until I was driving to work the next day that the penny dropped and I realized I should consider the possibility that the email was fake.  Still I was a little reluctant to abandon my preexisting belief even as I added up the considerable evidence favoring fake.

Fortunately my mistake will apparently have no serious consequences.  I am not sure any of the information I provided actually got back to the sender as I didn't complete the form and submit it (whereupon according to the link above I would have been redirected to a genuine American Express page).  In any case I notified American Express that evening who told me they hadn't been any recent activity on my card and that I wasn't responsible for fraudulent charges.  All in all they didn't seem very concerned but did give me an email address to forward the fake email to.  I did so and received an acknowledgement so I think I am covered.

I was a little concerned that the email might have ill intentions besides eliciting sensitive information (like for example encrypting my hard drive and requesting ransom to decrypt it) but the link above seems to discount any such possibilities. 

Wednesday, February 20, 2019

2018 Portfolio Review

In 2018 my brokerage account performed slightly better than the market.  As usual I will use the Vanguard S&P 500 ETF, VOO, as my benchmark.  VOO was down 4.37% (6.31% capital loss partially offset by 1.93% of income).  My account was down 4.21% (6.67% capital loss partially offset by 2.46% of income). Unlike last year I had some transactions during the year which makes breaking down my overall performance a little more complicated.  Aetna (AET) was bought by CVS near the end of 2018, I will figure the performance for the year by taking the year end value of the cash and CVS stock I received.  I also made four stock purchases in the fourth quarter, I will figure yearly performance by assuming I had set aside the cash needed for these purchases at the beginning of the year.  I will continue to ignore the interest earned on dividends I received during the year.  I included the (approximate) interest paid on the cash assumed to be set aside for investment but ignored the interest paid on the cash I received for AET.

At the beginning of 2017 I had  46.59% of the value of my account in VOO, 12.76% in other ETFs, 31.48% in individual stocks and 9.17% in cash (of which 4.50% was used near the end of the year to buy some more individual stocks).  VOO of course matched the market.  The other ETFs collectively underperformed (mostly because of the poor performance of the energy ETF, VDE) and contributed  -.31% to my overall relative performance.  My individual stocks collectively outperformed despite the fact that most (11 out of 17) of them lagged the market.  This was because of AET a big holding which was my best performer (up 11.92% even after accounting for the later drop in the CVS stock I received for it as most of the purchase price was paid in cash).   They added .44% to my overall relative performance.  My stock purchases (BLK, MET, TD and some more CVS) were largely poorly timed coming just before the year end market drop. Collectively they contributed -.28% to my relative performance. My remaining cash of course outperformed a down market contributing .31% to my relative performance.  This all adds up to .16% of outperformance as expected.

As noted above my individual stocks collectively outperformed the market even though many did poorly. Only two (AET and BBL) outperformed by at least 10% while 8 (ALL, BNS, CAT, CM, IBM, WBK, WFC and XOM) underperformed by at least 10%.  The remaining 7 (ED, INTC, JPM, NSC, PEG, SOUHY and TGT) were within 10% of the market performance.  Fortunately the outperformance of AET (whose good performance in previous years had led to it becoming an oversized position) was enough to bring the collective performance above that of the market.

As noted I purchased some stock during the year.  But not enough to use up the cash I received from the AET forced sale.  So my cash position increased to 13.19% at year's end.  I have a general intention to keep this account fully (or nearly fully) invested but in practice this requires more effort than I have been willing to devote to selecting and purchasing stocks.   As it was my buys were not all that carefully researched.  I bought the CVS to bring the share count up to match what my AET share count had been.  I have an account with TD (TDBank) and feel more comfortable investing in companies I have some sort of positive (or at least neutral) relationship with.  AET is my health insurance provider and did very well so I bought MET (MetLife) which provides my dental insurance (both through my employer).  BLK (Blackrock) was my pick in an out of favor sector (which promptly got a lot more out of favor).  I considered other investment management companies like IVZ (Invesco), LM (Legg Mason) or FII (Federated Investors Inc.) which were cheaper in terms of earnings yield but seemed more dependent on high fee active funds (which don't in my opinion have a promising future).