<< Back to All NewslettersThe Lost $5.3 Trillion U.S. Sovereign Wealth Fund
As bad as the “War on Drugs” has been, it’s actually been worse than most people realize. In fact, the drug war is an example of the worst kind of public policy mistake: one that does not accomplish its stated goals, causes significant and lasting social harm (millions of lives destroyed), costs the country massive amounts of money, and prevents taxpayers from seeing the benefits of that money directed more productively elsewhere.
Doing something prevents you from doing something else. The choice to do anything is really the choice not to do all of the other things you could have done. So, not only did the United States government allocate this money poorly, but we also missed the opportunity to use that money productively elsewhere – i.e., what is the opportunity cost that was wasted by deploying capital in such an irresponsible way?
Rather than having spent this money on drug enforcement, we posit that the U.S. government should have taken a page from the book of Norway, Saudi Arabia, and Malaysia: Startup a sovereign wealth fund. As to this fund’s performance, let’s take the easiest and most stark example we can think of in regards to investment strategy: what if the Federal Government had instead just taken the direct drug war costs and put them in an S&P 500 index fund for taxpayers?
How large would the seed investments be in our new U.S. wealth fund? The general direct costs of the War on Drugs are fairly well understood. Over the last 40 years, the Federal government has spent $635B on drug enforcement policy according to a study published by the Strategic Studies Institute at the U.S. Army War College. When one adjusts these numbers for inflation, the total cost quickly balloons to over $890B (a nice $2,700 stimulus check to every man, woman, and child in the United States).
If we would have taken the tax dollars allocated to the S&P 500, our Sovereign wealth fund would be doing great right now. Just looking at the first $171 million allocated to drug enforcement by Nixon in 1971 (or $1.1 billion in 2021 Dollars), that sum alone would be up 172x to $30 billion. On the whole, the $890B of federal drug war spending balloons to $5,333B or $5.3 TRILLION. Equivalent to 28% of the U.S. GDP in 2019 or 20% of the current outstanding U.S. national federal debt. And this only refers to the direct costs...
During the War on Drugs, drug use and American deaths due to it grew to all-time highs. It is a shame the amount of taxpayer money squandered on something worse than fruitless. In an upcoming blog post, we will be digging deeper and looking at how the negative impacts of incarceration on individual income has massive ripple effects across the greater economy - some of the more indirect, but very real, costs of the War on Drugs.
Sources:
Walther, Michael F, and U.S.. Strategic Studies Institute Army War College. Insanity: Four Decades of U.S. Counterdrug Strategy. Carlisle, PA: Strategic Studies Institute, U.S. Army War College, 2012. Web.. https://lccn.loc.gov/2016388354.
What Costco Can Teach Us About Cannabis
Costco is a phenomenal company and a recent episode of Business Breakdowns, a new podcast from Patrick O'Shaughnessy (host of Invest Like The Best, an interview series with investment professionals), took a look at some of the reasons underlying its success: Maniacal Focus on the Customer: Jim Senegal, one of Costco’s co-founders and the CEO that oversaw much of its early growth, instilled an almost unparalleled focus on the customer and perfecting Costco’s model to increase customer value. This ethos still makes up a significant portion of the company’s DNA. Leveraging Advantages: 75% of Costco’s operating margin is generally the subscription fees its customers pay. This allows it to run very low gross margins on products and still ultimately be profitable - everything that makes people continue their membership is ultimately a good deal for Costco. The bigger Costco gets, the broader the selection and bigger the discounts - a virtuous circle that tech investors dream about that was happening for decades in large warehouse stores. Careful Margin Expansion: 25% of Costco’s sales are Kirkland Signature store brand products. Costco has been methodical about giving their customers a quality, budget choice - and with a legitimate focus on the “quality” aspect. Often Kirkland Signature is not the cheapest product Costco offers. Costco has grown its house brand enough to make it the largest standalone brand in America by sales volume. Highly Considered Product Selection: Costco runs about 4,000 SKUs vs. a typical store’s 40,000. It coordinates deeply with its vendors and, even though it is a hard negotiator, is able to leverage large volumes into significant discounts it passes to customers. Costco also takes months vs. the over year average of most stores to try new products on shelves, allowing it to quickly test demand, apply any information learned, and continue to iterate. Retail is Detail: A famous saying of Jim’s, it embodies Costcos focus on the little things that provide small, compounding advantages that competitors haven’t matched. Things like forcing suppliers to package in form factors that are shelf-ready and can also be stocked on pallets easily, which allows Costco to utilize more of each stores’ floor space as selling space (vs. a typical Walmart which has 30% of each store as inventory storage), and larger form factors that minimize shrinkage. This list should give a flavor of what makes Costco great, but it is certainly not exhaustive. How do these Costco core competencies translate into financial performance vs. competitors? Fairly well: Source: quickfs.net The stock market has generally rewarded Costco with a higher earnings multiple. Below is a graph of Costco vs. Walmart P/E multiples over time: Source: macrotrends.com As it relates to our little corner of the investing world, Costco holds some lessons for looking at cannabis companies. Not because MSOs should focus on copying what Costco did by rote - store brands, leveraging discounts, etc., are all tools that have their place but mindless copying is not the point - but because it's important to keep in mind how current US MSO financial results reflect investments for future compounding. Costco wasn’t always rewarded with a premium multiple. For much of its earlier history, many observers did not quite understand its advantages and how it was compounding them. Costco would build 20-30 stores per year, with an initial capital expenditure on the building, merchandise, etc. for a new store costing tens of millions of dollars (about $100m is what it costs today). But each store by itself only contributes 3-8% in margin, with about a 10% free cash flow yield on the initial invested capital. In most years, because of the expansion, Costco wouldn’t show much in the way of earnings or EBITDA at all. But the additional stores led to more buying power, which led to better value for customers, which led to more memberships, which led to a compounding machine that only became obvious to everyone years later. While it’s more difficult for investors to see, coming to an accurate conclusion about whether an MSO is wisely investing into becoming a platform for compounding value, like Costco, is likely much more important than tracking whether a company met or beat analysts’ quarterly EBITDA estimates. Again, US MSOs shouldn’t copy Costco’s business by rote but should look at the underlying themes and reasoning for hints as to what could help them build value in their markets. Except for $1.50 hot dogs, which the MSOs should mindlessly copy immediately.