2025 Annual Letter

Framework for Interpreting Results

The Futility of Annual Measurement

I take neither credit nor blame for annual performance. Because our strategy is predicated on capturing the underlying return of the business (shareholder yield + conservative growth) with zero reliance on multiple expansion, short-term results are often distorted by market sentiment. This strategy can only begin to be judged over a full 5–7 year cycle, as it often takes at least that long for the business's compounding power to overwhelm the noise of multiple contraction or expansion.

The Volatility Mismatch

The strategy has been run at a level of monthly volatility that is not compatible with most institutional mandates. For the first time, I must address the "negative" aspect of this volatility.

There is a deliberate reason for this perceived madness. I have always believed that volatility is not risk. To use an analogy: if you owned a local pizza restaurant and people offered you wildly different prices for your stake every day, those bids would not change the risk profile of the business itself. However, if you took that restaurant public and called it Domino’s Pizza, finance professionals would suddenly label the stock’s price movement as "risk."

Legendary investors have long shared this view. Charlie Munger famously noted that if you know what you are doing, three stocks are plenty. Warren Buffett exemplified this by once putting roughly 40% of his firm’s assets into American Express. Stan Druckenmiller summarized the philosophy best: "Put all your eggs in one basket and watch that basket carefully".

If one truly understands a business that is highly predictable, it is mathematically inferior to "diworsify" into marginally lower-returning assets. I would prefer a 14% return with far higher volatility over a 13.5% return with far less volatility because I am volatility agnostic; my singular priority with proprietary capital is to maximize risk (permanent loss of capital) adjusted returns. This explains my extreme concentration and considerable utilization of leverage since inception.

Using the same philosophy, single stock shorts have been utilized not to hedge volatility drivers of long positions, but rather to achieve the maximum amount of alpha irrespective of their relationship to the long side of the portfolio. This beta mismatch further contributed to volatility, particularly this year, as the fund’s shorts would often go up at the same time as the longs declined and vice versa.

I recognize that for the vast majority of institutional clients, this level of volatility is unacceptable; thus, changes as outlined later in this letter will be implemented around the middle of 2026.

4 Significant Contributors to Results

British American Tobacco

BTI, the fund’s largest position at the start of the year, which I have written about extensively in prior letters including the 2023 annual letter, was up about 54.95% in 2025. The business continued to (1) raise prices faster than volumes declined, (2) make steady progress in next generation products such as vaping, and (3) return capital to shareholders via dividends and buybacks. The stock did not perform well this year due to a catalyst; instead, market participants seem to have become more aligned with my view of the quality of the business’s earnings, resulting in multiple expansion that has pulled forward some of the returns expected from this investment. For further context on our British American Tobacco thesis, see Appendix A (excerpt from 2023 Annual Letter).

PetMed Express

PetMed Express is a leading online pet pharmacy business in the United States that predominantly delivers prescription and non-prescription pet medication to consumers. The stock had traded as high as about $45 per share in the last 5 years and as high as nearly $6 a share in the last year.

This year I had been watching the stock because the balance sheet was substantially net cash and the business owned a 180,000+ square foot warehouse facility on 14 acres of South Florida land, which I believed to be worth substantially more than it was marked at based on the purchase price nearly a decade ago (Miami area/Palm Beach population and real estate values have obviously grown substantially). The business was shrinking, but it had a substantial runway. Moreover, with a non-staggered board and an upcoming shareholder meeting, I figured if management continued to perform poorly and not put the company up for sale, then I or someone else could run a proxy to replace the board and sell the company and/or its assets.

I saw limited long-term downside, and many ways to win, I aggressively acquired shares at an average cost of $1.68 (near the $1.57 low) and within less than 2 weeks of buying the business received two take-private bids and the stock jumped over 100%.

Evolution AB

Evolution has been a meaningful detractor from 2025 performance. In my view, the stock’s decline can be attributed to two distinct factors. The first relates to legitimate concerns around Evolution’s moat and cybersecurity exposure in parts of Asia, which does reduce intrinsic value, though I believe the market has overreacted and the shares remain highly attractive. The second relates to European regulatory concerns, which I believe are not material to the long-term earnings power of the business.

In parts of Asia, Evolution’s games are frequently accessed by end users in jurisdictions where online gambling is not formally legal. Importantly, Evolution does not knowingly sell into sanctioned countries or to illegal operators. However, in these “gray” jurisdictions, the illegality of online gaming at the end-user level weakens Evolution’s moat. End users face far more friction when switching operators, which reduces the leverage Evolution typically has over its customers (the operators) relative to its regulated markets.

Compounding this issue, certain operators—often with a high degree of technical sophistication—have been illegally capturing and rebroadcasting Evolution’s live gaming streams to monetize them without paying Evolution. There is evidence suggesting that, in some cases, this activity has been conducted by Evolution’s own customers, effectively reducing Evolution’s realized fees. This creates a difficult tradeoff: if Evolution does nothing, it risks further economic leakage; if it enforces its rights too aggressively, operators can switch to competitors, while end users may not be able to migrate as easily to a new operator offering Evolution’s superior products due to local constraints.

Recently, Evolution acknowledged that it pushed enforcement too far in certain Asian markets, which negatively impacted regional revenue. Critically, management admitted that this 'over-extension' of technical countermeasures unintentionally blocked legitimate VIP players, creating a self-inflicted revenue disconnect. While reported Asia revenue showed a headline decline of 6.5% in Q3, the underlying organic performance was more resilient; adjusted for significant currency headwinds, global revenue growth remained positive at 3.9%. Ongoing cyberattacks and regulatory turbulence—such as partner license issues in the Philippines—have added to the volatility. However, it is vital to distinguish between partner-level issues and Evolution’s core infrastructure. While a local partner recently saw a B2C (consumer-facing) license revoked due to KYC failures, Evolution’s B2B (studio) license in Cebu remains fully operational. This new studio acts as a physical 'firewall' for the region, providing localized, low-latency streams that are structurally harder to pirate than European feeds. At present, there is no clear or elegant solution to this problem, and competition in the grey market is fierce. Thus, it is reasonable to conclude that the Asian business deserves a lower valuation multiple than previously assumed, reflecting a segment that is less oligopolistic and less predictable than Evolution’s regulated-market operations.

In Europe, concerns have centered on regulatory scrutiny following investigations into Evolution games appearing on unlicensed sites. In response, Evolution proactively implemented measures to prevent unregulated operators from offering its games across the EU and UK. While these actions temporarily impacted European revenue, they strengthened the long-term foundation of the business, reinforced regulatory trust, and ultimately enhanced Evolution’s competitive moat in regulated markets. Importantly, Evolution’s revenues are distributed across dozens of regulated jurisdictions globally, with no dependence on any single geography. Mature but growing European exposure is increasingly complemented by expansion in North America and other regions, rendering isolated regulatory events immaterial at the consolidated level.

It is also worth noting that Playtech—a significantly weaker competitor—covertly funded a smear campaign against Evolution, contributing to rumors, false accusations, and arguably unnecessary investigations. This created substantial noise around the stock. As with many product manufacturers—whether of casino tables, firearms, or other goods—Evolution cannot fully control where its products ultimately appear. The critical distinction is between a product ending up in illegal markets and knowingly selling into those markets. This distinction matters, and I believe it explains why regulators in key jurisdictions such as New Jersey have ultimately cleared Evolution of wrongdoing.

Overall, I expect Evolution to emerge from this period of heightened scrutiny without any material impairment to its long-term cash-generation ability. While the market is currently fixated on the temporary 90% VIP tax cap in certain North American jurisdictions, momentum is building behind the 'Full House Act' in Washington. Inclusion of this relief in the 2026 Tax Extenders package would ensure North America continues to perform well over the next 5-7 years. I believe the industry in general is going to be meaningfully bigger 5-7 years from now, and because of that I believe Evolution is going to grow along with the industry.

Stepping back, Evolution supplies live online casino gaming solutions to operators globally. The online casino supplier industry is oligopolistic, and Evolution is the clear global leader, with market share typically ranging from 50% to 70% in regulated markets. I believe its competitive position is exceptionally strong everywhere it operates, excluding some unregulated parts of Asia.

Evolution generates EBITDA margins in the mid-60% range or higher. These margins have proven durable despite competitors offering lower pricing. The reason is that online gamblers are loyal to Evolution’s games, not to the casino operators themselves. While operators receive consumer attention and often command higher valuation multiples, Evolution supplies nearly all of them and is the product end users ultimately desire. If an operator drops Evolution, which is challenging due to how Evolution embeds itself in operators’ platforms, its users tend to migrate to competing operators that still offer Evolution’s superior experience. As a result, Evolution’s pricing power endures. This resilience is evidenced by the fact that even during the recent 'cyber-war' in Asia, EBITDA margins remained within the 66–68% guidance range. This suggests that the 'Asia hit' is a volume-distribution problem caused by technical friction, not a fundamental collapse in the profitability or desirability of the games themselves.

Casino operators have expressed interest in vertically integrating live gaming, but in practice this has proven extraordinarily difficult. Large attempts, such as that of Sands, have failed, while smaller operators would not consider it at all. Evolution’s moat explains why.

The company operates dozens of large, high-tech live casino studios worldwide, each requiring redundant infrastructure, high-bandwidth connectivity, multiple camera arrays, live editing capabilities, cybersecurity measures, fraud detection, and high-definition streaming. Evolution hires and trains thousands of live dealers globally and invests more in live production and game development than the rest of the industry combined. Competing offerings remain inferior due to technical latency, lower uptime, and an inability to replicate Evolution’s game variety at scale.

In addition, Evolution makes substantial ongoing investments in regulatory compliance, maintaining licenses across dozens of jurisdictions. Its games are deeply integrated into operator platforms, creating high switching costs and further reinforcing its position. Operators are incentivized to maintain these relationships due to performance uplift, player trust, and low operational risk. Evolution’s pace of innovation—consistently launching new live game formats—continues to outstrip competitors, further entrenching its platform globally.

Today, the business trades at approximately 10–11x free cash flow, carries a net cash balance sheet, has minimal capex needs, and returns essentially 100% of excess cash flow to shareholders through a mix of dividends and share repurchases—representing a total shareholder yield approaching 10%.

In my view, market skepticism driven by regulatory noise or regional concerns fails to properly account for the durability, diversification, and quality of this oligopolistic leader’s earnings power.

Shorts

As can be expected when markets are up double digits and the fund is beta negative the entire year, shorts detracted significantly from performance. The reasons for being beta negative this year were vast and were extensively outlined in the previous annual letter.

I am astonished by the valuations of some stocks in the market. Palantir, a company that might produce around $2-3 billion of FCF next year is worth almost as much as all public companies in Mexico combined and that of other mid-sized economies. I have been right on the trajectory of Tesla’s business as competition has eroded its margins and led to a negative growth rate in the historically horrendous automobile business, but the market has awarded this dismal business performance with a $1.5 trillion valuation. Tesla may lose money or be barely profitable in 2026 but its market cap is about 2/3 that of all companies in Germany, the world’s 3rd largest economy. Tesla’s discounted cash flow being comparable to that of all of Germany’s companies combined is possible (anything is possible!) but for it to be priced in reflects an environment that is in a state of total delusion. The only rational explanation for this is an exuberant view of the future, which is a microcosm of the current market paradigm, and why my short book has continued to detract from performance.

For our perspective on current market valuations, see Appendix B (excerpt from 2024 Annual Letter).

Philip Equities as a Business: Detailing the Transition

Mark Daniel, a Thiel Fellow who previously co-founded a private investment platform with Steven A. Cohen, has joined as CEO to lead all business and client functions. We have been close friends (and even roommates) for a decade, and his skill set perfectly complements my singular obsession for investing. One of the common pitfalls talented investors make as they want to grow their business is that they attempt to be a world-class CIO and a world-class CEO simultaneously. Both Ray Dalio and Bill Ackman have talked about this challenging dynamic at length, and the result is that both the performance and the business suffer. We consider ourselves lucky to get ahead of this issue now.

Punk Rock to Coldplay

In April 2025, when Mark and I began laying the groundwork for the future of Philip Equities he posed a question to me that hit me like a ton of bricks.

He said, “Josh, who’s the biggest punk rock band in the world?”

Of course, I responded with “I have no clue.”

And he replied, “Exactly, and that will be you if you’re not open to evolving”

Historically I have always prioritized the art of investing over the business of investment management. Philip Equities has been raw, eccentric, contrarian, intellectually honest, and authentic. Many of you have read my letters, admired them, and reached out to offer praise; however, praise is an insufficient propellant to enable me to accomplish my long-term goal of delivering the most dollars of alpha to clients. To achieve my objective, Philip Equities must shift from what has been the equivalent of a punk rock band to a commercially adored act like Coldplay.

What is Changing in 2026

Following a deep analysis of the last seven years of performance and a series of impactful conversations with a trusted advisor, we decided to evolve the business into a simple and scalable compounding engine with the requisite guardrails in place that will be compatible with institutional mandates. While I will continue managing my own capital in an unconstrained manner until our mid-2026 client launch, beginning mid-2026 we will align our strategy with institutional needs:

More positions: We will generally have 15–35 positions in the portfolio.

Single Name: 10% at cost / 15% at market

Top 5/ Top 10: 60% / 90% of NAV

Sector Cap: 40%

Liquidity Req: 90% ≤20% of 60-day ADV

Tax Efficiency: This reduction in concentration will naturally lead to longer hold times potentially enhancing after-tax returns.

Because I possess an abundance of high-conviction ideas with similar return profiles, the difference between my 6th and 15th best idea is generally marginal. By shifting to this 'concentrated with guardrails' mandate, we believe that we preserve the investment process while dramatically reducing volatility and sharply reducing blowup risk. While we will generally participate in broader market downturns, especially in conjunction with transitioning to a purely relative return product, we believe that we are dramatically reducing the idiosyncratic volatility that stems from extreme concentration to any single name. We believe that this makes us a dramatically less volatile partner for the long haul.

Let me be clear, the essence of Philip Equities remains the same. We are executing the same investment strategy run with proprietary capital since 2019. The changes being instituted consist of getting rid of leverage, shorts, and the extreme concentration.

For a 1% management fee, partners access what we believe to be a tax-efficient, risk-averse compounding vehicle where performance fees are earned only upon index outperformance.

To be clear: outperforming in any single year, or even a three-year period, is neither a goal nor a certainty. I can guarantee we will have years of underperformance, and our process is designed for a 5-7 year horizon.

What Is Not Changing

Business not stock price: I do not care how a stock trades. I care how a business performs. I buy when I believe that the owner’s yield plus conservative growth offers an attractive long-term return with no assumed multiple expansion. I hold long-term while per-share value compounds. Full stop.

Risk means permanent loss: Volatility is not risk. Drawdowns that let me buy more of the same dollar bills for fewer cents are welcome. I am indifferent to stock price movements over months or quarters or years.

Simplicity beats theater: Ballpark intrinsic value is enough. I lower estimates until I have high conviction in conservative estimates of normalized prospects, which allows for a low discount rate. To reach certainty estimates typically need to be reduced to such an extent that the opportunity is unattractive. If a thesis needs heroic forecasting or spreadsheet gymnastics, I move on.

Endurance over excitement: I do not seek clever ideas, nor do I require a year-end "catalyst" to justify a position. I believe that most hedge funds operate on a treadmill of high turnover, chasing aggressive re-ratings and aim for a high return for “the year.” This creates a desperate need for constant news flow and time-sensitive theses. If a boring company offers a predictable 12–13% return—consisting of a healthy dividend, consistent share buybacks, and modest single-digit organic growth—a typical fund might reject it as boring or "dead money" because it lacks a near-term spark to ignite the stock price. For us, that "boring" 13% is the gold standard. We do not need a re-rating to win; we simply need the business to distribute and deploy cash as expected. Our approach to generating performance is built on three transparent pillars: Owner’s Yield, Conservative Growth, and Zero Multiple Expansion. If a thesis requires the market to suddenly "wake up" and pay a higher multiple to make the math work, it is a speculative trade, not an investment. Time is the enemy of speculative trade, but it is the greatest ally of our portfolio.

Predictability over promise: I tend to focus on what I consider oligopolies and entrenched incumbents in slow-to-change industries with pricing power, predictable normalized prospects, and rational capital allocation. I do not fund cash burners or early-stage science projects. We seek to make long-term oriented investments to receive predictable cash flow streams; we are not in the business of adventure capital or any form of trading.

Value knows no borders: I believe that most "global" funds are merely US funds in disguise, hugging a benchmark dominated by American tech. I reject home bias. I allocate capital strictly where the discrepancy between price and value is widest, mindful of corporate governance, currency exposure, and geopolitical and domestic political risk, but regardless of the exchange. If the most durable cash flows at the lowest valuations are found in London, Amsterdam, or Almaty rather than New York, then that is where I allocate capital. I buy what I believe are mispriced businesses, not zip codes.

Hunting grounds of mispricing: My search for value often leads to three types of market dislocations. First, I seek structural disfavor. I am willing to own what others are forced to sell. Institutional mandates, ESG constraints, and thematic "shunning" often create a forced-selling environment that decouples stock prices from underlying cash flows. I am happy to be paid a premium to provide liquidity to those who must sell for non-economic reasons. Second, I pursue quality arbitrage. I do not penalize a world-class business for its zip code. The market frequently applies a "country discount" to dominant, high-ROE monopolies simply because they are listed on exchanges that lack the prestige of New York or London. I view these as opportunities to buy quality businesses at unfair "distressed-quality" multiples. Third, I look for entrenched plumbers. These are the "unsexy" incumbents that provide the essential infrastructure of the global economy. They may be capital-intensive, operationally complex, and utterly boring to the "fast money." These entrenched oligopolies possess high barriers to entry and inflation-protected cash flows that can frequently be bought at a steep discount. I do not need a narrative to win; I only need the business to continue performing its vital, unnoticed function.

Stock selection drives results: I am sector, market cap, and geography agnostic inside my circle of competence.

Active share over index-hugging: I have no interest in matching a benchmark. Historically, this strategy has generally maintained an Active Share of 90%+, ensuring the portfolio is a high-conviction operation fundamentally decoupled from the index. Even with increased diversification, and even at a serious scale, I intend to generally maintain this 90%+ profile to avoid "closet indexing" and ensure every dollar is allocated to our best ideas rather than market-matching theater. I do not aim to have an opinion on every index constituent, and the investment process will never include any consideration of overweighting or underweighting a name relative to the index.

Time arbitrage: I will wait years for a fat pitch and happily do nothing in the meantime. When the market misprices a high-quality cash stream, I act immediately and size with intent. If necessary, I will wait a decade for a stock to produce a return that I know its underlying business supports, and place neither attention nor consideration to multiple contraction, negative sentiment, or the concept of “dead money.” To be clear, the portfolio as a whole can generally begin to be judged after 5-7 years, but an individual stock even after 5-7 years can have a return that is inconsistent with the underlying business performance. For example, if one buys a stock with a 10% owner’s yield and zero growth, one expects a 10% return. However, if that stock’s multiple is cut in half over a 5-year period, the resulting contraction cancels out the yield entirely, leaving the investor with a 0% total return despite the business being fundamentally healthy. As you can see, multiple expansion and contraction is generally the dominant contributor to a stock’s return over short periods of time.

Concentration with discipline: I would rather own more of my best five to ten stocks than sprinkle capital across 150 stocks. When the odds are a cinch, I press. When they are not, I pass.

Behavior as an edge: I have removed noise from my life. No committees. No expert networks. No fundraising duties. No operational duties. I read, think, occasionally allocate capital, and wait.

Panic is a gift: The best entries have historically come when blood was in the streets. I will continue to lean into dislocations when fundamentals are intact and position more conservatively when exuberance turns the market into a voting machine.

Readiness: Most of the work lives on the watchlist. I keep it fresh so that when price meets value I can act in minutes, not months.

Alignment and frugality: The majority of my liquid net worth stays invested alongside partners. We strive to keep fixed management company costs low so that the business endures under all circumstances. We strive to keep fund company expenses low (especially as we scale) to increase alpha. Turnover is generally low (aside from crises/dislocations) which has tax benefits. These tax benefits are critical for the taxable investor, yet often overlooked. Most active managers from high-turnover pod shops to standard L/S and long-only funds suffer from chronic tax drag. While the former incur expensive short-term gains practically on their entire return each year, the latter often realize long-term gains far too frequently. Our approach focuses on both avoiding short-term rates and extending the deferral window for long-term gains. By significantly reducing the frequency of realization events, we intend to achieve even greater alpha for taxable investors when comparing after tax returns to some of these competitors on an after tax basis.

Activism when logic requires it: I prefer to back rational managers and companies with adequate corporate governance. When governance or capital allocation blocks value, I will engage, propose solutions, or pursue creative and sometimes legal paths to protect and create value. I will ruthlessly maximize value for our partners; there is no other consideration.

Same mission, same temperament: I intend to run capital the same way at 81 as I do now at 31 and as I did in 2019 when launching Philip Equities from my dorm room. Same philosophy. Same process. Same patience. Same indifference to short-term stock movements. Same long-term goal.

We are excited for this next chapter. Our investment objective is simple: maximize the total dollars of alpha for our partners over the coming half century by owning predictable, cash-generative businesses at sensible prices inside what we believe to be a bulletproof, scalable machine. For prior annual letters, further insights, and more detail on the transition, please visit philipequities.com or contact Mark Daniel at mark@philipequities.com.

Sincerely,

Appendix A: British American Tobacco Investment Thesis

Excerpt from 2023 Annual Letter

The other capital allocation decision did not contribute positively to the mark-to-market performance and involved British American Tobacco (BAT). Given the fund's longstanding concentrated investment in Imperial Brands, the further foray into the tobacco business was made with the industry firmly within my circle of competence.

In contrast to some of the fund's short positions that, perplexingly, seem to capture the crowd's excitement, I perceive British American Tobacco as an exceptionally enticing growth business. This is underscored by its consistent growth in revenue, operating profit, and earnings per share, even amid various headwinds. Market participants, accustomed to favorable economic times and rising earnings per share, appear to overlook the value inherent in a dependable and growing cash generation machine. Perhaps when economic conditions become less optimistic, the true value of this gem may be duly appreciated.

Unlike Imperial Brands, which focuses its operations on five core developed markets, British American Tobacco (BAT) has a longer tail of combustible tobacco earnings, driven by its robust presence in emerging markets. A firsthand experience during a two-month stay in Indonesia revealed the astonishing popularity of cigarettes. In fact, nearly two out of every three Indonesian males smoke.

To put it lightly (no cigarette pun intended), market participants continue to underestimate the tobacco business, particularly BAT. Following the FDA's ban on some VUSE flavors (integral to BAT's next-generation products), the stock experienced a significant drop. This decline was further fueled by the noise surrounding the UK's new smoking legislation. Despite being a highly predictable and economically resilient growth business, BAT traded at around 5x earnings during this period, prompting me to increase its position, making it the second largest in the portfolio.

To echo Marcus Aurelius, "The object in life is not to be on the side of the majority, but to escape finding oneself in the ranks of the insane." The UK legislation is expected to have minimal impact on the tobacco business in the next five years. Even with the assumption that such legislation remains in place, it is unlikely to deter younger adults from exercising their freedom of choice to smoke. Do younger adults under 21 and under 18 in the US drink? Did younger adults in the US use cannabis while it was illegal to produce, sell, and consume in all states? Now imagine that we are assessing a highly addictive substance that is legal to consume (just not to purchase for some age groups); what an irrelevant piece of legislation. Furthermore, in contrast to the prevailing view that only old people smoke, the smoking rate in the UK among the 25-34 year old age group is 16.3%, which is almost double the smoking rate of the oldest group aged 65+.

BAT's recent foray into a "smoke-free" future created a stir, marked by a substantial write-down of its US combustibles business last December. This led to a further drop in the stock, prompting me to seize the opportunity and increase my position. Many market participants may not realize a crucial fact: the goal of being "smoke-free" is oddly defined as less than 5% of adults smoking. For instance, Sweden is about to become the first "smoke-free" country despite 5% of its adult population smoking. To illustrate the absurdity, consider this: if 4.9% of all adults were considered deadbeats, would we call the country "deadbeat-free"? It's a nonsensical statistic seemingly constructed out of thin air to provide politicians with a false accomplishment to tout.

If BAT pursues its "smoke-free" goal by 2035, this politically correct objective implies a projection of further steady declines in the smoking rate in developed markets (not groundbreaking news). Even if, in some developed countries, less than 5% of the population smokes in 2035, it would still represent a significant market share. Many companies could only dream of capturing 5% of developed market consumers. In a "smoke-free" world, BAT's combustible profits in these developed markets are likely to increase due to price hikes and margin expansion. The combustibles business in emerging markets will surely not be "smoke-free" by 2035. If BAT succeeds in substantially increasing the penetration of non-combustible products like vapor products in developed markets, this cannibalization may further contribute to the company's growth in earnings.

The vapor market is frequently misunderstood. Currently, BAT and other regulated players face a challenging environment due to the proliferation of illicit players in the market. Presently, the vapor market resembles the wild west, with illicit flavored products more prevalent than regulated products. However, what often goes unnoticed is the fact that today's illicit vape users, part of a super high-growth market, are likely to become the regulated tobacco vape users of tomorrow.

Governments are bound to become increasingly frustrated by missing out on tax revenues and allowing their constituents to use potentially dangerous products. This frustration is likely to prompt crackdowns on illicit products and/or a shift away from authoritarianism, liberating adults (at least of some age groups) to exercise their precious free choice in selecting flavored products that enhance their lives. A similar paradigm unfolded when consumers couldn't use Juul flavors, leading them to migrate to BAT's products. A comparable migration is anticipated once there's a crackdown on Elf Bar and similar illicit vape products.

Now, many individuals will overlook these facts and concentrate solely on the combustible volume decline in some markets as evidence of a declining business. However, this is a prime example of an unidentified cognitive bias, and I'd like to name it "Univariate Obsession Bias" – a term I would cheerfully suggest to Charlie Munger if he were still around to add it to his wonderful list of 25 cognitive biases.

Univariate obsession bias occurs when individuals fixate intensely on a single variable (univariate) within a multifaceted situation, disregarding other crucial factors. To illustrate, consider the debate on working remotely vs. working in an office. People often exclusively focus on the hours worked variable, stating things like "people just don't work as hard." However, hours worked multiplied by productivity equals output, and ignoring the productivity variable is asinine. Intelligent individuals make this mistake due to the irrational univariate obsession in society with "hard work," despite productivity being the more critical variable to output since its potential increase is not limited. Perhaps their fixation on hard work stems from focusing on it during their careers, leading to cognitive dissonance, a separate cognitive bias.

Another example of univariate obsession bias arises when I mention living in hotels/Airbnb instead of purchasing a 365-night bulk lease (i.e. a 1-year lease). People immediately say something like "that must be expensive!" In this case, people have a univariate obsession with the median price per night, which tends to be marginally higher at hotels. Still, due to this univariate obsession, people disregard various other key variables, such as living in hotels enabling the hotel-liver to avoid spending double his/her median price per night (often much more) for many weeks or even months each year while away from their contracted 365-night Residence.

In the tobacco business, both prices and volumes contribute to sales. The dynamic of prices rising as fast as volumes decline in this business leads to higher margins. The univariate obsession bias on "volumes" tends to confuse people from recognizing the significance of other material variables.

Appendix B: Historically Rare Financial Market Exuberance

Excerpt from 2024 Annual Letter

In typical fashion, I would use this space to introduce new investments; however, given the current climate of financial upheaval, I feel compelled to shift focus and delve into why such opportunities are conspicuously absent.

It seems the pervasive exuberance in today's market escapes the notice of many. When financial historians eventually turn their attention to this era, they'll likely recognize it as one of the most pronounced anomalies in market history. Allow me to illustrate my point:

• The storied days of the Peter Lynch PEG ratio have vanished. High-caliber companies with seemingly reliable growth prospects command multiples that seem detached from their intrinsic value. Take Cava, for instance, which trades at a price-earnings multiple in the hundreds with growth around a mere 20%, or the various larger stocks such as Apple with around a 40x multiple on high quality earnings but predictable and lackluster growth prospects.
• Consider Dogecoin, a dog joke meme turned coin with zero intrinsic value, amassing a market cap of approximately $50 billion—a sum comparable to Latvia's GDP. Does a prudent person prefer the hard-earned contributions of nearly two million individuals which can be turned into a future endowment for their family, or would they prefer to gamble it away on Dogecoins? Buyers of Dogecoin and all the other speculative coins are speculating on the advent of a greater fool.
• The Buffett Indicator hovers around an all-time peak. Even after adjusting for growing non-U.S. earnings, the indicator is still at record levels.
• Remarkably, the Shiller P/E Ratio surpasses its pre-Great Recession and pre-Great Depression levels, approaching heights witnessed just before the .com bubble burst.
• Corporate insider sales have recently surged to a two-decade record.
• On non-fundamental news unrelated to future cash flows, stocks have spiked. For example, Workday recently surged on inclusion to the S&P 500 Index, and earlier this year Gamestop jumped based on memes posted on a Twitter account.
• Tesla ascending sharply, propelled by substantial volume despite clearly deteriorating fundamentals. Margins are on the decline, growth is flatling, and past projections seem foregone.
• One meme coin, born from a jest about oral sex, rapidly achieving a market valuation near $500 million—absurdity materialized.
• Even within the last fortnight, I've received messages surprisingly from non-idiots urging me to buy "fartcoin," a cryptocurrency whose market cap astonishingly resides in the billions. Clearly these folks are experiencing FOMO.
• Many meme stocks like GameStop, previously identified with spur-of-the-moment trading fervor, linger at inflated levels far removed from their fundamental value.
• Real estate is not immune, with valuations adrift from fundamentals, being sold and marketed at cap rates in the vicinity of the risk-free rate.
• Sovereign debt levels have soared to historic peaks.
• When I tell everyday people I am an investor, they show excitement about what should be a boring subject (investing) and ask whether they should invest in "hot" stocks such as Tesla or Nvidia.

This exuberance exists against a backdrop of 4-5% interest rates, ostensibly suggesting a stock price-earnings multiple of 20-25 if we assume zero risk premium—discordant given the historical 4-6% premium. Concurrent geopolitical tensions span the globe—from conflict in Europe, at one point looming Middle Eastern conflict prompted by Iran, to the continued U.S. and China trade and Taiwan tensions. Economic strife continues to grip major economies like Germany and the UK. U.S. GDP growth, rather than miraculous, is buoyed by unprecedented peacetime/non-recession budget deficits documented meticulously by the St. Louis Fed. The 2024 US fiscal deficit hovers around the same level as it did in the years coming out of the Great Financial Crisis (despite low unemployment). The University of Michigan Consumer Sentiment Index has been hovering at levels traditionally aligned with recession.

As I have repeatedly asserted, I hold no interest in ordinary deals and the slightest whiff of challenge is unappealing. I yearn for investments where the thesis is straightforward and even in the bad case scenario, results should remain favorable. These sorts of opportunities generally present themselves in times of panic rather than enthusiasm. In my judgment, despite pockets of decent value that can be safely captured while waiting for a dislocation, the evidence of historically extreme exuberance requires similarly historically extreme caution. To quote the revered Lao Tzu:

Do you have the patience to wait

till the mud settles and the water is clear?

Can you remain unmoving

till the right action arises by itself?

Other people are excited,

as though they were at a parade.

I alone don't care,

I alone am expressionless,

like an infant before it can smile.

He who rushes ahead

doesn't go far.