“25-year-olds should not pay a 31.3x Shiller PE to buy their grandparent’s equities”
“Let’s start with what I’d tell a 25-year-old to not do with investment capital,” answered the CIO. He’d been asked how our youth should invest for 10-15yrs. “I’d tell them to not blindly follow their parents and grandparents as they pay ever higher multiples for a shrinking pool of equity assets,” he continued. In 1982 when Baby Boomers were coming of age, they paid a 6.6x Shiller price-to-earnings ratio for the S&P 500. By 1990 when the median Baby Boomer was 35-years-old, they had bid the Shiller PE to 16.5x. That same year, Baby Boomers owned 33% of all US real estate assets by value. Fast forward to 2020, the median Millennial is 31-years-old and they own just 4% of US real estate assets. If they scrape together a few bucks after paying down student loans, they must pay a 31.3x Shiller PE multiple to buy the S&P 500. “To win a game, play to your strengths, exploit your opponent’s weakness,” said the CIO. “As people age their creativity slips away. Their imagination withers. Their risk appetite fades. Their ambition dwindles. Their drive slides. And this leaves them incapable of reimagining the world, let alone building that future,” he said. “But as people age, they do accumulate capital. And recognizing that this is their only remaining competitive advantage, they unsurprisingly lobby for policies that enhance its value.” Baby Boomers are the wealthiest cohort in all human history. They’ve shifted the game’s rules to entrench their interests. Which has both limited competition for their companies and artificially shrunk the pool of investable equity assets. “There’s too much capital in the world today relative to too few equity assets. 25-year-olds should not pay a 31.3x Shiller PE to buy their grandparent’s equities. They should play to their strengths and fight to build new companies that unseat established ones. Creating new equity assets to ease the acute shortage.”
Underutilized fixed assets
Underutilized fixed assets are the topic of this essay. But all the other variants, such as underutilized variable assets, are important to understand as well. Food delivery is a great example of this. Many people often express disbelief that food delivery startups, have been able to get as many restaurants to sign up for them while charging large take rates (sometimes north of 30% now) from the merchants. “How do these restaurants afford it?” these skeptics ask. What these skeptics fail to understand, is that restaurants do not view deliveries the same way they view customers dining in. There are many factors that restaurants are constrained on including, ingredients, labor, kitchen capacity, and dining space.
For walk-in diners, the primary constraint is dining space. There is an immovable cap on how many tables a restaurant has, and thus how many turns they can do a night. This real estate space is a fully utilized fixed asset. So a startup bringing new diners to a restaurant is entering a zero sum game, especially during peak hours when a restaurant knows they can likely fill all their tables. If a restaurant accepts a diner from a startup and pays them a take rate, this replaces a diner that would have walked in for free. This is the reason why restaurants often don’t list their prime hours on sites like OpenTable. They know they can fill their limited number of tables, so why pay OpenTable a fee for it?
But delivery is different. Real estate space is not relevant to delivery orders. Instead the two main constraints for restaurant delivery are labor and kitchen capacity. Kitchen capacity is an underutilized fixed asset. Most kitchens can handle more orders than they handle each day, but never need to because there’s not enough space in the restaurant for more diners. Like all underutilized fixed assets, restaurant owners are very happy to have their kitchens handle more orders if makes sense.
The other constraint is labor. Restaurants may have some underutilized labor, depending on how busy they are. However, if they have any significant number of delivery orders, they likely would need to have their workers do more shifts, or hire new workers. So labor is an underutilized fixed asset up to some point, but then primarily a variable asset for restaurants.
So when a startup brings new delivery orders to a restaurant, their main question is whether the delivery will be profitable net of the variable costs like ingredients and labor of the restaurant. Other factors like real estate costs are already fixed and so not factored in by restaurants. If these delivery orders are profitable, restaurants are happy to do any and all incremental orders–and will happily pay a higher take rate in return for bringing them the customer. And if the startup brings more customers than they have workers to handle–they’re overjoyed to hire new workers, as long as the economics make sense.
Variable assets are great because they can scale well. However, they are far less preferable to underutilized fixed assets for a number of reasons. Their primary weakness is that they can be copied by competitors. Underutilized fixed assets when discovered are have a huge amount of stored value. The first company to properly use them can increase their value significantly. However, after they’ve burned through this arbitrage, future competitors must find a new way to get advantaged distribution fast. This isn’t true for variable assets as we can see in food delivery. The field is increasingly competitive with Grubhub, Uber Eats, and Doordash all competing in increasingly costly battles.