Warren Buffett, once said: "If you've been playing poker for half an hour and you still don't know who the patsy is, you're the patsy."
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I don't play poker, and I don't know for certain what a patsy is, but I have an uncomfortable feeling that if I started playing poker, I'd be it. I always thought that Warren's game of choice was bridge, but perhaps if he can't find a good partner he chooses poker as the least worst alternative.
Poker, and gambling generally, of course have a lot in common with investing. Speculation is the game of guessing what the marginal investor is about to do, and guessing better than all the other investors in the market. It's certainly tough, and there are a lot of patsies, not least because it really is a zero sum game if you ignore fees, and if you pay someone to gamble for you, it's a negative sum game.
The nature of investing is that you can buy something only if someone on the other side of the bargain thinks that what you are buying is worth more than what he is selling. Given that you're probably buying from a professional, it's as well to think long and hard about whether that bargain you think you are getting really is such good value.
The same sort of reasoning goes for all goods and services: the guy who sells you a cappuchino in the morning definitely thinks that it's worth a lot less than what you are paying for it. Of course he has 'overheads' - fixed costs of production that he has to recover from your payment for your coffee. Economic theory says that at the end of the day, once he's paid for everything there are no profits, or 'economic rents' left. If he has a great spot then the person he leases his shop from will get all the benefit of his higher than average turnover.
This theory all seems pretty reasonable until one thinks of certain industries and service sectors. How can there be no rents in investment banking, even retail banking, the hedge fund 'industry', private equity, corporate law, defence contracting, even something like public works contracting? Well, I think the answer is that, actually, it's all to do with who is on the other side of those profitable transactions. My contention is that the common factor is that the when firms in these industries do their high-margin transactions, the party on the other side is ultimately the public, often represented by an agent who isn't really that bothered about seeking out the best deal for the principal.
Nearly all firms love to be contractors supplying government agencies. It's wonderful to be a stockbroker doing transactions on behalf of a fund manager who is looking after savings for a firm which has, somewhere, some annuitants who are hoping to get a good pension out of those savings. The same goes for a shipbuilder who has the capability to build an aircraft carrier for the British Government.
High margins can arise from lots of factors - innovation in product or production technology, patents, brilliant marketing, cheap capital or low production costs. But the only enduring source is the absence of competition, which usually goes with consumers who do not have the incentive to seek out alternative suppliers, or are prohibited from doing so by regulation. It's usually impossible to avoid paying the cost of these (set up your own hedge fund maybe?) but it is at least possible to buy the shares in some companies operating in that kind of business. Unfortunately many of the very high margins are associate with low capital requirements, so most, or all of the excess profits flow to managers, rather than owners, if they are different.