The market can keep rising until something changes
Why are prices for stocks rising? There are three main reasons that I can identify. The first is still simply expectations for falling interest rates. When does this get fully reflected in stocks? We may be there, but I would guess that momentum will carry stocks higher until we actually get the cuts.
The second factor is the consumer. Retailer and other results show that the consumer (whose spending is 2/3 of the U.S. economy) came through the 2023 Holiday shopping season in strong form. Fund managers who have underweight the consumer sector or were positioned defensively based on last year’s concerns have been forced to buy stocks. Third, I would cite the excitement around Artificial Intelligence (AI). AI is not new but large language models and the commercial application therefrom are recent developments. AI has moved from the theoretical to the commercial. The technology is way outside my area of expertise but I sense that it has “open-ended” implications. This puts it in a genre that could potentially cause investors to lose perspective and rationality. For the moment I see it as a positive for markets.
Last Month I Wrote that I had Sold Apple (AAPL) But Was Hanging on to Facebook (META)
On a very short-term basis, this has been the right call as AAPL is since down about three percent while META gained more than five percent. I outlined three criteria I use for selling a stock, 1) the company’s growth narrative is broken, 2) the price is ridiculous, and 3) I found something better to own. In AAPL’s case, I felt persistent weak revenue performance that I discussed was a challenge to the growth story and inconsistent with the shares’ premium valuation. I mused that AAPL shares were reflecting expectations for the company to enter (& dominate) another huge category such as automobiles. Well, the news came out during the month that Apple was abandoning its project to build cars. I have little doubt AAPL will find a way to reignite growth but in the meantime it feels like investors are paying for that growth without any visibility on what is going to create it.
This Brings Us to Costco (COST) and another Issue
COST shares have been in our client portfolio for over five years. Leaving behind the megatech names, most people are familiar with Costco (COST), the largest club retailer. I think it’s universally agreed that COST is an excellent retail company. The stock has been a massive outperformer for decades. Zeroing in on just the past five years the shares are up more than 200% including gains of more than 50% in the last 12 months. What’s the problem? The stock has materially outpaced the company’s excellent fundamentals. For example, earnings per share over the past five years have (only) doubled. The result is that COST’s valuation has expanded to the absolute highest level in the company’s long renowned history as a public company.
As you can see in the 10-year valuation chart, COST’s price to earnings (P/E) has vaulted to the mid 40s. Prior to 2019 the shares mostly traded in the 20s. The COST story remains excellent but is it materially better than five or ten years ago? I don’t think so. Do lower interest rates matter here? Sort of but not really. Is this a secret AI play? If it is, I am not in on the secret. In my view the stock is up because the market is up, investors are chasing performance, and not because Costco’s fundamentals have changed in a meaningful way. Is the price “ridiculous”? Many retailer stocks at 52-week or all-time highs but COST stands out based on its absolute multiple and the extent that its valuation is extended relative to history. I am reducing exposure.
Upcoming activities
I am flying to New York on Monday, March 4th.
The purpose of my trip is to attend the Target (TGT) analyst day and meet with clients. On Tuesday I will also give a guest lecture at Columbia Business School. The topic is going to be avoiding errors in the investment decision making process. I’m going to approach this more from a psychological perspective rather than delve into errors of analysis. It’s going to be really fun! I’ll record a condensed version will advise when I have uploaded it to YouTube. I have two previous lectures already up on the site, one on idea generation and time management and the second on the selling discipline. I don’t get paid for the lectures, but I like having the chance to think about investing at a higher level and to talk to students. To finish my trip, I’ll spend some time in Southampton, NY before heading to New Orleans to visit my daughter Ophelie who is a junior at Tulane University. If you’ll be in NYC, Southampton or New Orleans and would like to meet up, please send me a message.
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.
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The author of this letter and accounts managed by Quo Vadis Capital have a long position in shares of META and COST.
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