Questioning the Signaling Model of Education

I was an early adopter of the Higher Ed Bubble thesis. Like all early adopters, I’ve gotten skeptical now that it’s popular. I recently attended a talk by Bryan Caplan where he discussed his thesis that higher education is about signaling good qualities, not about attaining them. This explains lots of puzzles in the education market, from “will this be on the final exam?” to choosing English Lit over Computer Science to 40% absentee rate in typical college classrooms. One of the most compelling pieces of evidence for the signaling model: on average, one more year of education predicts 10% higher income for an individual. But it predicts 2% higher GDP for a country. [Citation needed: Caplan mentions it in his talk, but it is surprisingly hard to Google for.]

The trouble with signaling is that it’s too good. Signaling is always a possible explanation for phenomena that are visible but don’t have an obvious cause, but like lots of other powerful explanations (“market price” or “survival of the fittest”) it’s also strong enough to explain counterfactuals. It’s still valid and meaningful, but signaling is not necessarily a comprehensive model. And in this case there’s another model that can explain some of the gains: accumulating lots of knowledge is disproportionately useful in fields where a) winners win big, and b) growth in that field is has an unusually small impact on GDP growth. Read the rest of this entry »

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Snapchat as a Value Investment: A Mild but Timely Tweak to Discounted Cash Flow

Snapchat most recently raised money at a rumored $10bn valuation. All good MBAs know that the current value of a company is the value of all of its future cashflows, discounted back to the present. So all good MBAs consider these VCs completely insane. Or they would, except that implicitly people use two valuation frameworks: either they think of an investment in terms of discounted cash flows, or they think of it as a “strategic” investment. “Strategic,” in practice, means “clearly not the result of anyone’s realistic estimate of Snapchat Inc.’s free cash flow generation circa 2029, but not strictly crazy, either.”

But there is a fairly trivial way to square that circle. A company’s current value is the net present value of all future cash flows it can generate, or the amount of cash flow it can cause a single prospective purchaser to lose, discounted to the present. Read the rest of this entry »

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In Search of Negative Carry

One working definition of a professional investor is: somebody who needs to care about “carry.” The classic carry trade is the mid-90’s best against the Yen (I’m going to borrow from this Mark Dow writeup, because I am a macro tourist—literally, my main macro trade is that I avoid traveling to Europe when the Euro is strong). The Yen bet: the BOJ intended to keep rates low; rates in the US were high. So a smart person could borrow Yen, invest in USD, and pocket the difference. A smart person with risk tolerance could do this several times over, and make a very nice return indeed.

As it turns out, one risk of carry trades in FX is that they are a pretty good deal most of the time, so lots of hedge funds get involved, so when something else blows up, they unwind their carry trades, too. So at any given time: a) the carry trade is earning a positive return from the interest rate differential, b) the trade also has a tailwind from more people making the trade (ie every new “borrow Yen / short USD” transaction, but c) at any given time, there’s a possibility of a sudden and painful reversal.

Fortunately for anyone involved in such a trade, you earn your 2 and 20 on performance at a specific time, not on the expected contours of future performance. So for someone who wants pretty good odds of a pretty good return, a carry trade is a pretty good bet. Read the rest of this entry »

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Chicken-and-Egg Disruption: Misunderstanding YouTube, Uber, and AirBNB

AirBNB offers ubiquitous illegal rentals, says New York’s Attorney General. Uber gets shut down or hobbled in new markets around the world. Viacom’s legal department could have wiped out YouTube for ripping off their content.

At one level, you have to ask why somebody would build a business that’s either always illegal or probably going to be used illegally. If you want to be really contrarian, you could try asking that but not rhetorically. Read the rest of this entry »

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What Stock Option Pricing Models Tell You about Courting Controversy

“There’s no such thing as bad publicity” was surely coined by an otherwise bad publicist. Of course there’s such a thing as bad publicity, if you’re already famous.

If you’re not famous, there’s a tradeoff: at some point, it’s better to piss off most of your audience and impress a few people, rather than having no audience at all.

The Black-Scholes model provides a helpful way to look at this. The Black-Scholes formula allows you to price a stock option knowing only a few data points—the current price of the stock, the strike price and maturity of the option, the risk-free interest rate, and the stock’s volatility. Read the rest of this entry »


How to Short the Higher Education Bubble

You know the return on investing in college is low and declining. You know there are better alternatives to college. You know that “college for all” harms students—Harvard says so!

Some day, the education bubble will burst. How can you trade this?

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LinkedIn’s IPO Filing: Analyzing the S-1

Note to readers: my new startup research boutique, Digital Due Diligence, performs in-depth research on dozens of companies, public and private, including LinkedIn and its key competitors. Visit our equity research page for more information.

Last month, LinkedIn filed a prospectus with the SEC. It’s a great case study: LinkedIn is one of the largest social networks, and it may be the most mature of the major social networking businesses. Like Facebook, LinkedIn has turned a profit; unlike Facebook, LinkedIn’s profit is dependent on several known business models.

The filing itself was a better read than most. Among other risks, it cited the possibility that:

[O]ur initial public offering could create disparities of wealth among our employees, which could adversely impact relations among employees and our culture in general.

I guess that’s what you get when your Chairman is an avowed “free-market socialist.”

The hurdle LinkedIn’s IPO faces is that the easy comparisons are completely wrong. LinkedIn shouldn’t be valued like a job board: for a variety of reasons, it’s a much more defensible model; LinkedIn is likely to stomp all over the traditional job boards (not so much traditional recruiters). But it’s not a “social network” that can be valued like Facebook and Twitter. LinkedIn’s business model is already in place, and its potential is a matter of execution, not innovation. Read the rest of this entry »


Blogs are Here To Stay—Are Bloggers an Aberration?

It’s hard to say when the “blogger” phenomenon peaked. In the runup to the 2004 election, the media meta-narrative centered around “the blogger”—a possibly psuedonymous individual whose commentary was upending the traditional news cycle.

In the next few years, something strange happened: blogs became ubiquitous. But “the blogger” lost influence; the personalities that originally defined blogging never became as influential as most people expected.

I suspect that three forces sapped the blogging trend of most of its strength:

•Social media sites replaced low-traffic blogs.

•The right economic unit for high-traffic blogs is the blog network or the content farm, not the blogger.

•The only use for a blog qua blog is as an extended résumé or biz-dev pitch. Read the rest of this entry »


Will Disaggregation and Outsourcing Destroy the “Apprenticeship” Model?

Lawyers, consultants, and investment bankers follow a fairly similar career path: excessive hours and tedious work at the start of their careers, followed by vastly better compensation and marginally better hours later on.

This makes a certain amount of sense: the fastest way to get a decade of experience is do work double-time for five years.

The system works for people who are already in the industry: they get their grunt-work done. It works for people who are joining the industry: they learn everything they need to know, and the difficulty of the work allows the industry to keep an “up or out” structure along with a steady path for advancement.
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The Illusion of Social Progress

In the last 20 years, smoking has been transformed from something that seemed totally normal into a rather seedy habit: from something movie stars did in publicity shots to something small huddles of addicts do outside the doors of office buildings. A lot of the change was due to legislation, of course, but the legislation couldn’t have happened if customs hadn’t already changed.

—Paul Graham, The Acceleration of Addiction

“Whig History” is history rewritten to support a narrative of constant progress. The single best example I’ve found comes from David Brin’s essay on Lord of the Rings: JRR Tolkein — Enemy of Progress:

It’s only been 200 years or so — an eye blink — that “scientific enlightenment” began waging its rebellion against the nearly universal pattern called feudalism, a hierarchic system that ruled our ancestors in every culture that developed both metallurgy and agriculture. Wherever human beings acquired both plows and swords, gangs of large men picked up the latter and took other men’s women and wheat. (Sexist language is meaningfully accurate here; those cultures had no word for “sexism,” it was simply assumed.)

They then proceeded to announce rules and “traditions” ensuring that their sons would inherit everything.

Putting aside cultural superficialities, on every continent society quickly shaped itself into a pyramid with a few well-armed bullies at the top — accompanied by some fast-talking guys with painted faces or spangled cloaks, who curried favor by weaving stories to explain why the bullies should remain on top.

Only something exceptional started happening…

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