News reports claim that Canada and the U.S. have abandoned the search for downed floating objects. Apparently, the governments are comfortable that they may never have an explanation. In contrast, we continue to get plenty of shady explanations for floating stock prices.
Last year was a difficult year in the markets and for my strategy. I tend to favor companies that are growth oriented, and are high quality, and I like many tech business models. I generally try to stay fully invested. High quality, growth, and tech names advanced during 2020 and 2021. They did not outperform in 2022, to put it kindly. Of course, I wasn’t the only one caught in the downdraft, and the challenging year set up a generally downbeat attitude among investors at the start of 2023.
Stock price movements appear to be driving investor thoughts about the future, rather than the other way around. The consensus thinking at year-end was that Powell’s interest rate hikes were on a collision course with the economy. Inflation was eroding consumer spending and confidence. Stocks were expensive. Many more years would be required to unwind the excesses started in the wake of the financial crisis (2008-2009) and compounded during the Covid-panic. In other words, the outlook was abysmal. The more that stocks fell, the greater the explanatory force this narrative obtained, reinforcing the negative sentiment.
The trouble is that consumers don’t care what a bunch of overpaid hedge fund guys and gals think. Despite the drumbeat of negativity emanating from Wall Street and amplified by financial media, U.S. consumers (whose spending is accounts for more than 2/3 of the economy) were continuing to enjoy the lowest unemployment rate in 50 years and rising wages. Yes, inflation and fewer handouts from Uncle Sam were causing some budgets to break here and there, but generally people have kept spending. The 2022 Holiday sales season was solid and early 2023 figures have been stronger than expected.
A market rebound has ensued, and surprise (!) belief in the “soft-landing” has gained traction. When widespread pessimism collides with decent consumer and economic data, stocks go up. When stocks go up, a negative narrative sounds foolish. Ergo, investors start singing a new tune, this one cheerier. The “soft landing” is the idea that Powell and the Fed can steer the economy to happy place where both inflation moderates, and employment stays near current levels. With a soft landing, housing doesn’t crash, banks don’t pull back on lending, the consumer keeps spending, companies keep growing, and importantly stock prices stay floating high.
Except. In my recent conversations with retail and restaurant companies, not one said it was planning lower prices in 2023. Au contraire. It will cost more to eat at restaurants and shop at most stores. Why are pricings going up? It’s not out of malice. Costs are going up. Managements are expecting inflation in commodities and labor rates in 2023, at levels well above the Fed’s targeted 2% rate. It has been nice watching my portfolio regonfler year-to-date. But even with solid recent economic activity, the big picture inflation issue hasn’t gone away. The impact of the Fed’s interest rate hikes are still in front of us. And other cracks in the consumer’s financial position are ominously appearing in the data.
Own the Best Companies, Their Management Teams are Better Equipped to Deal with Foreign Objects
As investors we are constantly bombarded by attempts to fit a narrative to the noise of stock movements but frequently this only amounts to noise calibrated to noise. The future is inherently uncertain. Investing outcomes are determined in the future, not the present. Explanations for stock price movements are frequently backward looking, even though the market is supposed to be forward-looking. How can you get ahead of this cycle? My approach involves two components. First, embrace uncertainty. I pay attention to the economic data and the forecasts of those I respect, but I don’t to predict these things. This leads to a second component. I try to select stocks based on the quality of the business model, the company’s financial position, the integrity of a management team, its ability to grow, and secular tailwinds that I can identify. I leave the hard part, managing the business in uncertain economic conditions, to the company management teams. What I’ve learned is that most of the time, management teams listen to the signals coming from their businesses and ignore the Wall Street and financial media noise calibration machine.
Selection from our Client Portfolio Airbnb (ABNB) *
We wrote about ABNB last month.
At the time of last month’s letter, ABNB was trading at $100. Subsequently, the company reported sales and earnings that were much better than expected. I am happy to report this caused the stock to rise as high as $145. It closed Friday at $132. Last month, we argued that even though ABNB was trading at a hefty 6.5x revenues, the price was attractive when compared to its future cash flows. (Please see last month’s letter for the full explanation.) Let’s assume my evaluation was accurate at $100. What about at $132? What now?
I could tell you that when we re-ran a long-term cash flow forecast, the shares still screened attractively. I could also share a ten-year price target using my forecasts. This work suggests to me that the potential remains very attractive. These are good exercises and a valid approach. But let’s leave all those ratios and numbers and forecasts aside. The company is doing great. The business model is fantastic. It has tons of growth in front of it. Lastly, a snarky positive indicator is that both the Goldman Sachs and Morgan Stanley analysts have a SELL rating on shares of ABNB. They have been wrong and they are defending their bad calls. In our experience, when analysts are negative and a company is exceeding expectations, it nearly always means the stock price is going higher.
*This discussion is not a recommendation for any security. Speak to your financial advisor for advice that is tailored to your financial profile, risk tolerance and investment horizon.
Feedback and commentary welcome. Would you like to learn more about how we invest in the markets? Please click here to get in touch.
John Zolidis
President & Founder
Quo Vadis Capital, Inc.
John.zolidis@quovadiscapital.com
Mr. Zolidis founded Quo Vadis Capital, Inc., a Registered Investment Advisor (RIA) and research consultancy, in 2017. He started his career in finance in 1996 following degree studies in Philosophy at Kenyon College and the University of Oxford. He has followed U.S. consumer companies as a senior analyst since 1999, mostly on the sell-side, writing research for institutional investor clients. He also managed money in a buy-side role at a long-short equity fund over 2013-2014. He was named in the Wall Street Journal’s Best on the Street list in 2005. Mr. Zolidis and works from New York, NY and Paris, France or wherever he has his laptop.
Travel update: Heading to Florida and New York over the next two weeks. In early February I attended the annual ValueX Klosters conference in Klosters, Switzerland. Participants are charged with bringing “an investment idea worth sharing” to present to the group, although some claim stage fright and slack off. Last year, I gave a presentation on the infamous Chinese coffee company, Luckin Coffee (LKNCY). For this year, I was influenced by a debate among value investors between investing in “compounders” vs. “cigar butts”. Compounders are companies that can reinvest excess cash flows into their existing business, thereby compounding growth over many years. Cigar butts refer to very cheap stocks, almost left for dead, but like a discarded cigar butt, still good for a last puff or two. Among the challenges with the cigar butt approach, in my opinion, is that it requires exiting the position once the remaining value is realized (which hopefully made the price go up). In contrast, a compounder is stock that can be held for years, provided the company’s fundamentals remain intact. Anyway, for this reason, I decided to talk again about Luckin Coffee, which I believe is a compounder and has the potential for many more years of gains*. (*This is not a recommendation, consult your advisor.) If you’d like to see the slides from my follow-up talk, which are not yet posted to my website, please send me an email.
In New York I’ll attend the Target Corp. (TGT) annual financial community meeting. Then I will give a guest lecture at Columbia Business School. This is the fourth year in a row I’ll talk to a graduate level securities analysis class at Columbia. This year I am planning to discuss how to evaluate when to sell a stock. I think a lot of discussion in finance is focused on how to evaluate a company and when to buy. Much less effort is devoted to the tricky question of when to sell. I will try to record a condensed version of the talk and will post to my nascent YouTube channel following the discussion.
