👋Hello from the home office. No housekeeping today, so let’s get right into it.
Before we get started…
This article will do a lot of looking back. And it’s easy to say all of this was obvious in hindsight.
In every annual report, companies state their future intentions (i.e. their future business plans).
It’s our job as investors to assign a likelihood to those intentions. And figure out one, if they are realistic. And two, if they are realistic, why this company — and not their competitors — is in the best position to execute on those intentions.
💡The light bulb moment
I first heard the term “Apex Mountain” from The Rewatchables; a Ringer podcast. The podcast does deep dives on movies they deem “rewatchable.”
You know, those movies that suck you in when you’re flipping through channels. Movies that you can watch over and over.
They break up the podcast into different categories. Like most rewatchable scene, what’s aged the best, and is this an actor or director’s Apex Mountain? Meaning, is this their best work, the peak of their powers?
For example: Is Vince Vaughn’s Apex Mountain Old School or Wedding Crashers? I lean Wedding Crashers, but many would say Old School.
It got me thinking…
How could we apply the “Apex Mountain” framework to investing?
Most companies, whether young or mature, probably had one product that got them to where they are today. But will that same product lead their next leg up in market cap? Will it remain their Apex Mountain?
Apple TV+: Not many specifics, didn’t say how much it would cost??? They will have original content from Oprah, Spielberg, and Reese Witherspoon. That’s about all we know.
Apple News+ (The Netflix of magazines): Cost $9.99 per month. Combination of magazines like Time, Sports Illustrated, and Rolling Stone. In addition, they added publications like the WSJ, The Skimm, and TechCrunch.
Arcade: Made for gamers. One subscription, no ads — you can jump from your iPhone to your iPad — to your mac, and pick up where you left off. I took a peek. Their games look cool, but I doubt we’ll be seeing Madden, Call of Duty, and other popular games with this bundle. It seems they are curating the best indie games you find in the app store and sticking them in Arcade.
Apple Card: Apple’s take on a credit card. Built on simplicity, transparency, and privacy.
Looks great. Just like you would think an Apple product would look. Minimal design, no numbers, and limited text.
Important: We categorize investments in two ways. Strategic or tactical; occasionally, they can be both. Most of the trades we cover fall into the tactical bucket.
Strategic: Occasionally, we believe we have an insight into a company or theme and are willing to make a five to ten year investment to see if we are right. We are looking for businesses that have the potential to dominate their category and create a product or service that is not easily replicated.
Tactical: For these trades, we have a specific price target to take profits at and a stop to protect our downside. In simple terms, we try pick stocks that have the highest chance of going up in price, in a one to three-year time frame.
1. Stability leads to instability
The headline is part of a quote by the economist Hyman Minsky. He was referring to the economy in general but we can also apply it in the context of business.
When a business reaches a certain level of success, they can, if they aren’t careful, become complacent. They can lose focus on serving their customers and meeting their needs. And if they aren’t careful, competitors will come in and start encroach on their territory. This process could happen so slowly, that upper management might not notice.
Then one day… boooooom…They’re in a fight for their lives and their very existence is at stake. (think Netflix and Blockbuster or the demise of Sears)
Shares of Victoria’s Secret’s parent company, L Brands (LB), has fallen 45% this year and is one of the worst performing stocks in the S&P 500. In addition, they slashed their dividend and the leaders of both Victoria’s Secret and Pink resigned, reports Bloomberg.
How did it come to this?
Ed Yruma, a retail analyst at Keybanc Capital Markets, points out that making push-up bras, long a Victoria’s Secret staple, is something of an engineering challenge and a unique supply-chain capability. But newly popular styles like bralettes and sports bras can be made by many factories, he notes, and that has made it easier for new competitors to get in the game and tread on Victoria’s Secret’s turf.
In other words, they got complacent and didn’t innovate on the product that made them famous (push-up bra) and other companies introduced cheaper alternatives.
Dollar Shave Club
A good comparison is what happened between Gillette and Dollar Shave Club (DSC).
Gillette had firm control of the razor market, but many men just wanted a good enough razor at a fair price. DSC sourced cheaper blades from a South Korean Company, Dorco, made a viral YouTube video and sold directly to the consumer.
The result… They started taking share from Gillette. And eventually, Gillette started their own subscription razor business.
Today, any entrepreneur can build a Shopify store, source a product on Alipay, and set up shop in a few weeks. The advantage pre-internet companies had is slowly being eroded.
Down, but not out
All hope is not lost. They still have a dominant share of the underwear market and the most recognizable brand in the space. They have to get back to listening to their customers and serving them on their terms.
Victoria’s Secret was built when the world was supply constrained (pre-internet). Meaning, the only place you could buy a push-up bra was a Victoria’s Secret store in your local mall or from their catalog.
Today, supply is infinite. There are a million places you can buy a product that meets your needs. In today’s world, the companies who are closest to the customer will have a leg up on the rest of the competition.
2. Toll Brothers tops analyst expectations
How a stock reacts to information is often more important than the actual information.
Toll Brother (TOLL) beat both revenue and earnings estimates from analyst but offered weaker guidance for the 1st quarter of 2019. Initially, this was seen as bad news, but the losses have been recouped and the stock is trading higher on the week.
How to trade it
Since 2013, this stock has traded in a $30-$40 dollar range; with a few spikes above and below those levels.
If you are aggressive, you could be a buyer at the lower end of the range ($30). Stopping out with a weekly close under $30, and looking for a rotation back toward the top of the range ($40). Or hold and look for a breakout and move back toward the 2018 high print near $52.
• The reward/risk if you target $40 is 1.28 (not great)—Meaning you would make $1.28 for every $1 dollar risked.
• The reward/risk improves to 3.97 if you hold until the 2018 high print near $52. You just have to estimate how probable that is…
Other ways to trade
If you want exposure to a basket of homebuilders (recommended), there are two ETFs you should look at.
iShares U.S. Home Construction | Ticker ITB
SPDR S&P Homebuilders | Ticker XHB
Important: The top three holdings for XHM are Lowe’s, Home Depot, and Williams Sonoma; only five homebuilders round out the other seven. ITB is a better pure play on homebuilders as five of the top six holdings are homebuilders.
Let’s take a quick peek at their charts.
iShares U.S. Home Construction | Ticker ITB
Thirty dollars is a crucial level of support for this ETF. A break below could see a move toward $22.50.
SPDRs S&P Homebuilders ETF | Ticker XHB
This chart is similar to Toll Brothers. Price is trapped in a narrow range between $32 and $38 dollars. And remember, this ETF is not a pure play on homebuilders. Home Depot is this ETFs largest position.
3. Technical analysis
XLE | Energy Select SPDR ETF
Where are we at?
XLE has been trading between $64 and $78.50 since March 2016. Currently, the price has tested the bottom of the range—$60—and held. For now…
Buying at the lower end of the range, $64, stopping out with a weekly close under $61.50, and holding for a rotation back toward $78.50 produces an attractive R/R of 5.8 (make $5.80 for every $1 dollar risked; in % terms it’s 22.60% on the upside and 3.90% on the downside) (see chart above).
A break under $64, could lead to losses down to $50, a -22% move to the downside.
Quick facts on XLE
Seeks to provide exposure to the energy sector of the S&P 500 index.
Gross expense ratio: 0.13%—You pay 13 cents for every $100 dollar invested.
Options available: Yes.
Dividend yield: 2.90%.
Exxon Mobile (XOM) and Chevron (CVX) make up 42% of this ETF. Those two companies will have an outsized impact on its performance.
We have become an “asset-light” economy. Quote from Warren Buffett’s annual shareholder meeting.
FAANG stocks were crushed in October. Rally over?
These categories of smart home technology are poised for growth.
Public offerings: How Moderna Therapeutics wants to revolutionize drug manufacturing.
Two signs a recession “might” be near.
Canada is fragile.
1. Spotify vs the record labels
The above chart is Spotify’s gross margin since 2013.
As a refresher, gross margin is (Revenue – Cost of Revenue).
From an article by Music Business Worldwide:
During the last round of negotiations with the three major record labels (Universal, Sony, and Warner), Spotify was able to reduce their payout to the record labels from 55% towards 52%. Hence the bump in gross margin improvement
The reduction was granted on the basis that Spotify hit steep subscriber targets.
See the problem… The percentage Spotify pays out to the labels has a direct effect on their gross margin.