Negative sentiment about certain types of companies has caught my attention. Some of it feels extreme. When people say things like all companies in a particular sector should be avoided, that doesn’t make sense to me. With interest rates rising and funding for companies harder to come by, it’s reasonable to assume that companies will struggle and may even fail. But expecting all companies (in a sector or segment) to fail or not grow isn’t reasonable.

When sentiment is negative, that’s a sign that the market has negative expectations of a company’s future results. Said differently, negative sentiment is a prediction that the probability of a negative outcome is high.

Sometimes negative expectations don’t align with what’s happening within a company. It may have hit a rough patch, but its leaders have done things to get back on the right path. For example, they were focused exclusively on growth, which resulted in extreme negative profitability and a high burn rate. But now they’ve taken correction actions, examples of which could be focusing on more profitable customer segments or reducing headcount.

If the company continues to focus and take the right actions, eventually this will be reflected in their results. Then, market sentiment and expectations will become less negative (or even positive).

I’m curious to see how many companies will make this transition and prove the current market sentiment wrong.

This is my one-hundred-sixty-third weekly reflection. Here are my takeaways from this week:

• Schedule – This was the second full week of my schedule experiment. This habit is having a positive impact on my knowledge acquisition. I’m starting to think about a daily goal for number of pages read.
• Insights – Developing insights from data that’s readily available won’t generate outsize outcomes. Many people can do that. Cultivating qualitative insights and making decisions based on them isn’t something everyone can do. Therefore, those insights generate outsize outcomes when they prove to be correct.
• Consistency – Someone pointed out that one of my superpowers is consistency. I am consistent, but I hadn’t considered it a superpower. I’ve been thinking more about this.

Week one-hundred sixty-third was a great week. Looking forward to next week!

I was exchanging thoughts with an investor friend about other seasoned investors. These are investors with many decades of experience. They’ve typically been through multiple cycles and navigated them successfully.

My friend said he doesn’t believe in reading about the thoughts of seasoned investors. He wants to know what action they’re taking and what their strategies are—not principles or concepts. Because they don’t share their current actions or strategies, he doesn’t read any of their writings; to him, they’re not interesting or insightful.

I disagree with my friend. I don’t think it’s realistic to expect an investor to share his strategies or real-time investments. Doing so would likely mean more capital being deployed into those investments, which would raise prices and reduce returns. Why would anyone want that?

I also think there’s value in understanding the frameworks other people use to inform their actions. How they view and think about the world may be different and worth considering, even if you disagree with it. Lastly, there’s something to be said for the wisdom accumulated during decades of success. It’s taken these people a long time to figure out some of their insights. Even if you don’t agree, it’s worth listening them—it might take you decades to reach the same conclusion on your own.

I may disagree with elder investors’ views, but I actively seek out material in which they share their insights because I have respect for the wisdom they’ve accumulated over their successful careers. The wisdom might not be valuable at the moment, but it could be priceless at some point.

Some companies are fortunate enough to have large cash positions. To figure out the true value (or, for public companies, market cap) of the underlying businesses, you must take the cash into consideration. Enterprise value is an approach to understanding a public company’s value. Here’s the simplified formula:

      Enterprise value = market cap + total debt – cash

Let’s use an example. As of this writing, here are Zoom’s numbers:

      Market cap = ~$19 billion

      Debt = $0

      Cash = $5.41 billion

*Note: I included cash, cash equivalents, and marketable securities (treasuries and bonds) in the cash figure.

Here’s the enterprise value of Zoom:

      $19 billion (market cap) + $0 (debt) – $5.4 billion (cash) = $13.6 billion

This means the company itself is worth $13.6 billion.

Founders and investors talk about increasing the value of a company by executing. What they really mean is they want to increase the enterprise value of the company.

Clarity of thought is a key component of success as an entrepreneur (it’s also helpful in life in general). Some people are better than others at clearly communicating their thoughts. The good news is that clear thinking is something that can be improved.

Just like anything else you want to improve, you must practice it. So how do you go about practicing clarity of thought?

In my experience, writing is the best tool to improve clarity of thought. Writing about a topic forces you to focus your thoughts and organize them coherently so others can understand your points. I like to think of it as a mental workout. The more you write, the more practice you get at clarifying your thoughts.

If you want to think more deeply about something or improve your overall clarity of thought, consider picking up the habit of writing. My takeaways from publishing my daily writings for over three years are here.

I was listening to friends talk about a particular segment of the start-up market. They said it’s a bad market. All the companies operating in this market won’t make it. Because it’s a bad market and the companies in it are unprofitable, none of the companies are worth anything, and they should be avoided at all costs. They all agreed. It seemed harsh. I thought, The sentiment on this market is bad.

I believe that the market my friends were discussing is near the trough in its market cycle. They’re likely right that many of the companies won’t make it. But they shouldn’t throw the baby out with the bath water. Some companies are risky but promising. Their upside is more probable than their downside, given how bad sentiment is.

I’m going to spend some time trying to find these companies.

I was chatting with a family member about something I want to accomplish. They started asking questions about how I was going to do it. “I don’t know,” I repeatedly said. They were puzzled. They couldn’t understand why I was okay not knowing how I was going to accomplish my goal. This intrigued me, so I began asking them questions. I eventually learned that they associate a clear path to a goal with a high likelihood of success. Said differently, if you know what steps to take ahead of time, you’re likely to be successful (if you put in the work).

No clear path means uncertainty, which scares many people. That’s understandable. In my experience, an unclear path can be scary but isn’t insurmountable. If you can figure things out as you go, you drastically improve your probability of success.

I first realized I could figure things out when I was a kid. I tried to convince my parents to let me do some hairbrained side hustle. They reluctantly agreed, to my surprise. That’s when I realized I had to figure out a lot of stuff to make the side hustle work. I had no idea what to do or how to do it. Eventually, I figured it out by talking to people and doing research. There were some bumps along the way. But to my parents’ and my surprise, it worked out. I made some money and learned how to figure things out.

The ability to figure things out is key to dealing with uncertainty. If it isn’t a skill you were born with, it can be learned. All you need to do is practice by . . . trying to figure something out.

An entrepreneur friend keeps close tabs on how public software businesses with recurring revenue are valued. He feels confident that in a high-interest-rate environment, free cash flow will play a bigger role in the valuation of these and other types of public companies than it has in the last decade.

It occurred to me that most people likely don’t know what free cash flow means. Free cash flow is a measure of how much cash a company generates (or consumes) that’s available for management to use at their discretion. For example, they may use it to pay dividends or for share buybacks. It’s important to note that free cash flow is different from net income (net profit)—mainly because of accounting rules. For example, some things that add to or subtract from net income don’t involve the company spending or receiving cash (e.g., depreciation). Companies can lack profitability but still generate free cash, and vice versa.

Here’s the formula: free cash flow = operating cash flow – capital expenditures

Operating cash flow can be found on the statement of cash flows. I won’t get into the details, but it’s basically how much cash company operations generate. It’s different than capital cash generated or spent from investing and financing activities. If a company sells widgets, it measures how much cash it consumed or generated just from selling widgets, not from investing the company’s cash or raising debt or equity.

Capital expenditures can also be found on the statement of cash flows. This is usually a measure of how much capital was spent on assets that will be depreciated over a period. Think buildings or pieces of machinery. Buying assets isn’t an operating expense, but it does reduce cash available for management to use and thus reduces free cash flow.

Free cash flow is a good concept for entrepreneurs to understand.

This is my one-hundred-sixty-second weekly reflection. Here are my takeaways from this week:

• Schedule – This was the first full week of my schedule experiment. During week one, I was able to do significantly more long-form reading. And I had some interesting insights as a direct result.  
• Banking – The First Republic Bank failure wasn’t a surprise. Interest-only mortgages being a contributing factor was. I’ve been thinking about the impact this product likely had on high-end real estate prices. It’s also got me thinking about where we were in the credit cycle when these loans were made and where we currently are.  
• Timing – I’ve been thinking about cycles and timing of ideas. Understanding where we are in a cycle can help you understand when the time is right (or wrong) to do something. Still thinking about this and getting the perspectives of others.  

Week one-hundred sixty-second was a productive week. Looking forward to next week!

The venture capital world has changed a lot in the last year or two. The good times when money was free flowing are no more. To better understand what’s happening, I decided to zoom out a bit. I’ve been reading about cycles in the investing world across various asset classes.

I’m not an expert on this. I’m still learning, but from what I’ve read so far, a simple concept describes what happens. When a strategy generates outsize profits, it attracts attention. Investors take notice. More capital is invested in the strategy. As more capital is invested into the strategy, it becomes institutionalized and has more capital to deploy than there are good investment opportunities. When that happens, returns (risk-adjusted) go down. As things perform poorly, attractive investment opportunities that generate high returns (risk-adjusted) can be found.

The public markets were hot in 2020 and 2021. Lots of venture funds saw their portfolio companies IPO (or do a SPAC) or get acquired, which allowed funds to return cash to their limited partners. Those returns didn’t go unnoticed. Over the last two-and-a-half years, venture funds raised larger funds—just before public markets began declining. It’s much harder for funds to raise today, but the capital already committed to those funds likely hasn’t been fully deployed (for a variety of reasons).

Sentiment in venture isn’t as hot as it was in 2020 or 2021. But it isn’t negative. Many funds probably have ample undeployed capital. Fund managers still have enough cash flow from management fees on committed capital to fund their lifestyles and firm expenses, and they can stay busy trying to deploy their uninvested capital. Limited partners likely haven’t seen markdowns on venture fund investments yet because many portfolio companies have been putting off raising.

I’m wondering when we’ll move into the next part of the cycle, when sentiment in venture will be negative. I’d imagine a few things will have to happen first. Limited partners will have to see their venture fund investments performing poorly (i.e., funds marking down their investments). Fund managers will have to run out of capital to invest, see their cash flow from management fees reduced or close to running out, and face difficulty raising new capital from limited partners. When (if) this happens, I think venture sentiment will be negative and closer to a low point. This will make people rethink careers in venture and limited partners rethink investments in venture.

We’re not there, but I’d imagine we’re headed that way if the current macro trajectory continues. Again, I’m still learning, so these thoughts may (and likely will) change. But that’s my thinking as of today.