👋Hello from the home office. Hope your week has been great!
On to the update:
Question of the week
The WSJ asks:
“Is this a healthy correction in a bull market with further to run, a reset lower in belated recognition of this year’s geopolitical risk, or the start of a new bear market?”
Our view: Trying to figure out how deep a correction will be or how long it will last is a waste of time because it is out of our control. All we can control is our behavior. Let’s focus our attention on deploying money into investments that we believe offer more upside than downside.
Here are a few of the IPOs for October. We will take a deeper look at these in November.
StoneCo-Ticker: STNE. A Brazillian online payments processor. A good comparison would be Square’s product that retailers use to swipe your card at checkout.
• Launched in 2014, they are already the 4th largest payment processor in Brazil.
• Backers include Warren Buffett’s Berkshire Hathaway, Jack Ma’s Ant Financial.
• This investment was made by Todd Combs, one of Berkshire’s portfolio managers.
Yeti Holdings-They make branded coolers and other outdoor, recreational products. They will trade on the NYSE with the ticker symbol YETI.
• A couple brothers started the company in 2006. They were frustrated with cheaply built coolers whose handles kept breaking and their lids would cave in.
• Net revenue-Grew from $89.9 million in 2013 to $639 million in 2017. That’s a compound annual growth rate of 63%.
• Operating income-Grew from $15.2 million in 2013 to $64 million over the same period. That’s a compound annual growth rate of 43%.
• Net Income-Grew from $7.3 million to $15.4 million over the same period. That’s a compound annual growth rate of 21%.
Upwork-An online marketplace for freelancers. They will trade on the NASDAQ under the ticker symbol UPWK.
(When they use GSV, that stands for gross services volume. That number is the total amount paid by corporations and individuals to freelancers; not the amount going directly to Upwork.)
• They operate the worlds largest online marketplace that enables businesses to find and work with highly-skilled freelancers.
• As of June 30, 2018, their platform had $1.56 billion of gross services volume (GSV) across 2.0 million projects between ~375,000 freelancers and 475,000 clients across 180 countries.
• They (Upwork) believe the opportunity set for their market, measured by GSV, was $560 billion in 2017. McKinsey Global estimates that, by 2025, online talent platforms could add $2.7 trillion annually or 2% to global GDP.
• Revenue-Grew from $138.4 million in 2016 to $178 million in 2017.
• Gross profit-Grew from $101.9 million in 2016 to $137.10 million in 2017.
• Operating income-Loss lessened from -$14.4 million in 2016 to -$3.1 million in 2017.
• Net income-Loss lessened from -$16.2 million in 2016 to -$10.6 million in 2017.
• Top-tier VC fund Benchmark led the series B in oDesk in 2006. (oDesk and Elance merged in 2013 to create Upwork)
Recent IPOs are money losers
• In the first three quarters, 83% of U.S.-listed public companies IPOs involve companies that lost money in the 12 months leading up to their debut according to the WSJ.
• That is the highest proportion on record, breaking the previous watermark of 81% back in 2000.
People see these stats and say “we’re in a bubble”. In my view, we watch and react. If this is a bubble, the best thing we can do is to prepare. Prepare by doing sound analysis and sticking to what we know. Because if stocks do get crushed, some good companies will be thrown out with the bad and we want to be ready to put money to work.
What will the customer experience be like in 5-10 years?
Despite the emergence of Amazon, Shopify, and e-commerce in our culture, physical stores still account for 90% of retail spending in the U.S.
According to Axios, the big players in both worlds (e-commerce & physical) are betting the future of retail will be a hybrid of offline and online.
As they note, large Chinese retailers have been doing the hybrid model for years. Amazon just opened its third Go store in Seattle this month and plans on opening 3,000 by 2021.
In case you don’t know, an Amazon Go store allows you to pick your items and walk out the door. It is a cashier-less store. You connect your Prime account to the app, and machine vision takes care of the checkout.
What companies do we want to own in this new environment?
Do we own the retailers who are adapting to the new normal or the companies who will provide the retailers with machine vision technology?
While Amazon’s cashier-less stores are innovative now, will they be the only retailers who have this technology?
According to the article, Standard Cognition, a silicon valley startup, has developed an automated checkout system and is working with four retailers to outfit their 70,000 U.S. stores. (see above)
A secular shift, not disruption
In my view, this technology (automated checkout) will be table stakes for any retailer in 5-10 years. True disruption is when one company comes up with a new way to solve a problem and they capture all the new value they create.
It reminds me when stores, such as Kroger, added self-checkout machines. In the beginning, only a few stores had them. Now, it seems to be the new normal. No company gained a competitive advantage by installing them.
More thinking and research will need to be done in this area. It’s not clear which companies now or in the future will build a defensible position that others can’t copy.
Amazon has a head start, has prime members, and owns Whole Foods, which are located in high-income areas. Can they create a shopping experience so good that people will stop going to other stores? Hmmm….
Despite diverse sources of revenue, their core business, e-commerce, is slowing. (see below)
I have no insights into how Amazon’s various businesses will perform and develop in the future. That makes it difficult to take a position based on fundamentals.
This is what we know:
• Jeff Bezos is committed to the long-term. From his first shareholder letter in 1997.
We believe that a fundamental measure of our success will be the shareholder value we create over the long term. This value will be a direct result of our ability to extend and solidify our current market leadership position.
The stronger our market leadership, the more powerful our economic model. Market leadership can translate directly to higherrevenue, higher profitability, greater capital velocity, and correspondingly stronger returns on invested capital.
• They are the market leader in e-commerce and cloud storage (AWS). These two categories have the wind at their back as both categories are set to grow in the coming decade.
What we don’t know:
• How much growth is priced into this stock? In investing, it’s not how good their numbers are. It’s how good their numbers are, relative to expectations. You won’t find many Amazon bears on Wall Street…
For now, we will be watching the chart and taking a position only if the risk/reward is favorable.
Is 3M a leading indicator of the ISM?
Source: Deutsche Bank; @carquintanills
• 3M (MMM) is a manufacturing conglomerate that sells everything from scotch tape, post-its, and other industrial and healthcare products such as surgical drapes and teethe whiteners.
• ISM stands for the Institute for Supply Management. They conduct surveys. Their most followed survey is the ISM Manufacturing Index.
The survey measures 300 manufacturing firms. The point of the survey is to measure the manufacturing conditions of the country. A reading below 50 means manufacturing conditions are contracting; a reading above 50 means manufacturing conditions are expanding.
Since 3M is a supplier to a large number of company supply chains, Deutsche Bank thought it might be a good indicator to follow.
Will earnings suffer when the tax cuts expire?
The chart above shows the tax cuts contribution to earnings growth from 2018-2020.
The tax cuts contributed to 33% of the earnings growth in 2018.
Question? Does this really matter and is it priced into the market? What do you think?
Prices on our favorite eats are heading up
Three-quarters of earnings guidance from companies have been negative. (WSJ)
Why does this matter?
Stocks are priced not only on how well they do, but how well they do relative to expectations. It’s why you see companies trading lower even if they beat analyst estimates. They may have guided lower for the next quarter or year causing analysts to reevaluate their assumptions and price targets.
We pay attention because we are trying to understand the psychology of market participants.
For example, if a company fell short of analyst estimates and guided lower for the year, but still ended the week in positive territory, what would that tell you?
Equity sector flows
It’s helpful to see where money is moving in and out of. However, these numbers are lagging. We use this like we use the commitment of traders report (COT); to find extremes, and we are not there yet.
Any opportunity in U.K. stocks?
Brexit is the kind of risk stock investors hate: Unpredictable, noisy, irrational. Therein may lie the opportunity according to The Heard on the Street column (paywall).
From the article:
“Shares in small and medium-sized U.K companies, last month fell to their lowest level since early 1996, relative to other developed-world equity markets.”
There aren’t many options for investing in the U.K. if you live outside the U.K.
The only ETF I found was the MSCI United Kingdom ETF from iShares (ticker: EWU).
• Investment objective-To track the investment results of an index composed of U.K. equities.
• Exposure to large and mid-sized companies in the U.K.
• Fees-0.48% | You pay 48 cents for every $100 dollars invested.
Small and medium-size companies have been hardest hit in the U.K. The iShares ETF does not include small-cap stocks.
(click to enlarge)
The ETF is down 5.88% for the year. We would look to be a buyer around the $28 dollar level if it got there.
In my view, the R/R favors no position at this moment.
On “Invest Like the Best”, Patrick O’Shaughnessy interview Ryan Caldbeck, CEO of Circle UP, a private equity firm that invests in early-stage consumer brands.
Think products like the RX bar.
What I learned
Three important things Ryan believes matter with early-stage consumer brands.
• Product differentiation
Our view: Much of what he says carries over to public markets.
Thanks for reading,