The first posting in this series on capital allocation covered Ana Marshall’s how-to guide for institutional asset owners. This one shifts to a much different kind of allocation, concerning the choices made by business owners and managers that build or destroy value in their firms over time. Plus, it deals with those concepts in a fictional setting.
The novel currently in hand is The Rebel Allocator by Jacob Taylor. It tells the story of a low-key billionaire — Francis Xavier (“Mr. X,” sometimes called “The Rebel Allocator” in press accounts), who owns a company called Cootie Burger — and the young narrator, Nick, whose chance encounter with Mr. X blossoms into a series of meetings between them about business decision making (and a deep personal connection).
Lesson plan
Mr. X imparts his lessons to Nick by having him read a succession of business observations from notable figures, which form the basis for discussions about putting those ideas into practice, mapping out Mr. X’s allocation and business philosophy in the process.
In a note at the start of the book, Taylor writes that it started out as nonfiction; he wanted to create a book about “capital allocations done right.” His chief source of inspiration is Warren Buffett. The bulk of the observations given to Nick for study are from Buffett; Mr. X shares more than a few personal characteristics with Buffett; and Taylor says in his acknowledgements that “most of Mr. X’s sage quotes are often directly cribbed from Warren and Charlie.”
To illustrate the core allocation concepts, Mr. X uses three straws (from Cootie Burger) to show Nick the simple but powerful relationships between cost, price, and value — and how profit (price minus cost) and brand (value minus price) are altered by various business decisions. (The straw formations are shown in the book.)
Story
Nick was raised by anti-capitalist parents and he settled on a journalism major in college, where he became known for “exposés taking down nefarious companies” in the school newspaper. But he ended up applying for a job at a private equity firm called Big Rock, which in turn encouraged him to get an MBA after hours. It was through that program that he won a drawing to join others in visiting “The Wizard of Wichita” (Mr. X) — in the same way many students have met “The Oracle of Omaha” in real life.
During their visit to Wichita, Mr. X tells the students to focus on their inner scorecards:
Don’t spend a lot of time worrying about what other people think of you. Progress is only accomplished by those who are stubborn and a little weird.
That sounds great, but it is difficult to put into action; the pressures of keeping up and fitting in mean that the inner scorecard gets overwritten by others. Nick’s struggles in that regard form his personal story, which proceeds alongside (and is related to) his philosophical apprenticeship with Mr. X. He faces problems typical of people fresh out of school, including the burden of student loans, learning the ins and outs of an organization, and diving into unfamiliar work — along with juggling his studies, a girlfriend, and regular visits to Wichita for his meetings with Mr. X.
Themes
Capital allocation. Toward the end of the book, Mr. X offers a definition of capital allocation:
At the most basic level, it’s how you decide to spend money. But it’s even deeper than that. Successful capital allocation means converting inputs like money, materials, energy, ideas, human effort, into more valuable outputs. It’s that transformation process.
By that point, he had provided examples of decisions at Cootie Burger, from small but important ones (often recommended by junior employees, who are closest to the work and the customer) to those more grand in scope.
The capital allocation philosophy offered by Mr. X often gets lost in the habits and practices of those running businesses, especially if they are attempting to meet the expectations of public markets or private equity investors. Different scorecards.
Continuous improvement. Mr. X thinks that many in business are looking for a silver bullet that “you fire once and it’s game over,” but:
My view is that there are no silver bullets. You’re either getting slightly better or slightly worse every single day. There’s no stasis.
Beware projections. In contrast to much investment analysis, Mr. X stresses that there’s no right answers to be found in forecasting, so it’s best to think in terms of probability distributions. Unfortunately:
It’s easy to fudge the projections on individual projects and make the numbers work. . . . Humans tend to be overconfident and extrapolate in straight upward lines when they get excited.
Doing deals. It shouldn’t come as a surprise that Mr. X is wary of doing deals, which people often undertake for the wrong reasons:
First is just the thrill of action — to be in the game, to make something happen, even if it’s stupid.
The second wrong reason is size, status, and ego.
I’ll classify the third as general overconfidence. If you’ve had some recent successes, you might think you’re on a hot streak.
Some more of his thoughts on the topic:
Never trust pitch books put together by investment bankers. It’s funny — they can give you precise numbers for what a business will earn ten years into the future, but they can’t tell you what their own business will earn next month.
Beware buying anything late in the cycle when everyone wants in. Usually the biggest and most colossally stupid activity occurs late in the game, near the top.
Private equity. Because of Nick’s job at Big Rock, the contrasts between that firm’s ethos and the beliefs of Mr. X are impossible to avoid. When he first went to work there, Nick could see that in some cases private equity served as a “white knight,” turning things around for the better, but at other times it behaved “like a short-term renter — a squatter even.”
Mr. X referenced the problem of investor expectations regarding returns within a certain time frame: “It can really cloud a decision maker’s thinking when there’s a shot clock.” To which Nick replied, “At Big Rock, they’re always looking to turn things around as fast as possible and then sell before the wheels fall off.”
Psychology. Mr. X relayed that he’s “never been afraid to reach over the fence to grab helpful ideas, no matter the source,” citing psychology in particular. In the book there are references to the subjective experience of customers and how the perceived value of a product translates into brand power — as well as explanations of the dynamics of social proof, delayed gratification, and other concepts.
Communication. While Nick’s journalism background was not ideal for a private equity analyst position, his ability to communicate gave him a different kind of advantage versus others (one that is too often not nurtured in the investment world). It also was key to his being selected by Mr. X to convey his story and ideas to others.
And Mr. X repeatedly demonstrated the importance of simplifying a message to yield understanding. At one point Nick thought to himself, “The old man had a knack for distilling concepts that tangled my brain at work and school.”
That other allocation
The book prompts questions about another kind of allocation, the one between work life and personal life. As the story nears its conclusion, it is clear that Mr. X had made choices in which he sacrificed the latter for the former. Were they worth it?
Additional information
Taylor is CEO of Farnam Street Investments; his client letters can be found here. Also online is a compilation of “Rebel Resources” that includes two appendices from the book, as well as “cutting room floor materials,” a bibliography with links, and a large number of white papers, articles, and shareholder letters authored by others. A rich trove of information.
The book is best suited for those interested in learning about the basics of capital allocation and business management. Readers early in their careers might also see themselves in Nick as he navigates his first job in a competitive organization and searches for his own inner scorecard.
The entire series may be found here.
Published: March 21, 2024
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