Market Talk, January 30th 2022
Market Talk is a free Sunday issue, where I share a curation of the best things I have consumed during the week.
Each Sunday I will share:
• A quick word from me
• The greatest articles I have read during the week
• The best pieces of company-related insights I have consumed over the week
• One stellar podcast or interview
• Something interesting
Comments from Me
It’s earnings season, and with Mitek Systems and Apple reporting last Friday, I will be sharing a stream of short memos on each of the companies I own and their respective earnings over the coming weeks. I will also be sharing a quick memo on Freetrade in the coming days.
If you would like to support this newsletter and get access to additional content, you can subscribe to Investment Talk here.
📈 Market Action 📉
The S&P 500
Sectoral ETFs for the US
🌎 Global Indices 🌎
Europe & UK
🔇 US Market Sentiment 🔇
Fear & Greed Index
The CNN Greed and Fear Index measures market sentiment based on seven factors; momentum, price strength, price breadth, put/call ratios, junk bond demand, volatility, and safe-haven demand.
The current reading stands at 36 down from 43 last week.
Major Earnings for the Coming Week
Some of the major earnings for the upcoming week, compiled by Fincredible.
Articles of the Week
Here is a shortlist of a few interesting pieces that I have read over the course of the week, to feed your mind.
Note, these articles are not numerically listed in order of perceived value.
To access the suggested article, click the purple link after the source subheading.
1) Interview with David Kim: Part 2
Length: Moderate Read
Source: (Liberty’s Highlights)
David Kim (aka Scuttleblurb) is one of the OG’s of equity write-up/deep dive (whatever you wish to label it as) newsletter game. For me, this was an interesting follow-on from Liberty and David’s first interview back in 2020. Whilst this interview was great learning material for me (an aspiring writer), the conversation panders out into reflections and commentary on certain companies and investment processes. A very enjoyable way to spend 5-minutes of your day.
““Fluff” is also friction, avoid fluff, of which there are two kinds (I’m guilty of both at times). There’s the stylistic kind where you overwhelm the reader with jargon and needless sentences. And then there’s the more insidious content-specific kind where you don’t make a meaningful point. A nice trick here is to ask yourself if any reasonable person would agree with the inverse of your claim. If not, then is your claim worth making in the first place? “We strongly believe that the best companies have durable competitive advantages, innovative cultures, and are managed by aligned founders who strive for non-zero sum outcomes”. That’s motherhood and apple pie. I have yet to come across an investor who argues for narrow moat enterprises with torpid cultures led by rapacious hired guns.”
2) Vision Capital Investor Letter 2021
Length: Moderate Read
Source: (Vision Capital)
Eugene (the solo LP at this fund) humorously opens the dialogue to this annual investor letter with “Dear Investor (to myself as the single LP)”. Whilst he may be the solo LP at this fund, it doesn’t take away from the learnings within.
With the first year of underperformance under his belt, Eugene shares his grounded response, highlighting the inevitability of periods of underperformance, the flaws of rotation, the alpha which comes from holding great businesses and not trading them, and much more. I don’t think one has to necessarily agree with the portfolio selection here in order to get benefit from the conversation within. Great reflections.
“The vast majority of our returns and alpha that we generate come from the ability of the companies we own, being able to continue to grow rapidly, being able to reinvest their retained earnings at high rates of return due to strong unit economics, solid balance sheets and attractive profitability. Durability of these companies matters, their persistence to keep growing matters, and our ability to hold them through market sell-offs matters. In our view, it would be a terrible mistake to sell some/all of these good businesses in order to invest temporarily in cheap companies which are much poorer fundamentally still, but could have a greater temporary recovery potential”
3) Calculating Return on Invested Capital
Length: Moderate Read
Source: (Credit Suisse)
This is another of those pieces that can be tucked away in your bookmarks folder for frequent visits. Calculated return on invested capital (ROIC) by Michael Mauboussin and Dan Callahan (2014) is an ‘oldy but a goldy’. First detailing (with case studies) the calculation for ROIC, the authors then continue to explain the nuances; the practical issues in calculating ROIC.
Here, they touch on the adjustments related to cash, goodwill, restructuring charges, leases, minority interests, R&D capitalisation, and buybacks. Somewhat of an elevated and more digestible version than what the CFA would provide you with, but without the annual recurring fees.
“A core test of success for a business is whether one dollar invested in the company generates value of more than one dollar in the marketplace. Warren Buffett, the chairman and chief executive officer of Berkshire Hathaway, calls this the $1 test.1 Logically, this occurs only when a business earns a return on investment in excess of the opportunity cost of capital. Here’s an extremely simple example. Say a company invests $1,000 in a new factory and estimates that the cost of capital is 10 percent. Were the factory to generate $80 in after-tax earnings into perpetuity, the market value of the factory would be $800 ($80/.10) and the investment would fail the $1 test. Earnings of $120 would create value of $1,200 ($120/.10), hence passing the $1 test. As companies announce investments such as acquisitions or capital expenditures, the market renders its judgment as to whether the investments add or detract from value.”
4) Being an Amazon Seller in 2021: Year in Review
Length: Moderate Read
Source: (Molson Hart)
Molson Hart is the founder of Viahart, an e-commerce focused educational toy company that did $8.8M in sales last year. Considering that 91% of those sales came from Amazon (down from 98% in 2018), this in-depth review of the problems this seller is facing was fascinating to me. I think anyone who is interested in Amazon, or the e-commerce space generally, should read this one.
Whilst the piece does cover some other fragments of their sales distribution (eBay, Walmart, and wholesale), the majority of the discussion circulates around Amazon-specific issues like; Amazon search, their reviewing system, Amazon policies, undercutting, and suspensions, as well as touching on how inflation and supply chain woes have impacted their business. An engrossing tale that also serves as a primary insight into being a seller under Amazon’s regime.
“Realistically, we’re stuck with Amazon. Yes, we tentupled our wholesale sales, but in absolute terms we added $219k. The 16% growth we got from Amazon was over $1.1 million. If we sold our best seller Brain Flakes to Walmart (the stores, not the marketplace), Amazon might play second fiddle, but would we be better off? We’d be stuck with a capricious buyer instead of a marketplace and what if our products hit the shelves and then didn’t sell? Bad news. Before reading this article had you heard of Brain Flakes? What is going to make you stop and buy something you’re not familiar with when walking down the Walmart aisle?”
Other Items I Read This Week
Note: ($) indicates there is a paywall on this content.
• Vision Capital: Investor Annual Letter 2021
• Doomberg: Dollars Ex Machina
• More to That: The Time Trap of Productivity
• Musings on Markets: Inflation and its Ripple Effects
🕵️ Company Insight 🕵️
• MBI Deep Dives (PINS): Building the Taste Graph ($)
• Ensemble Capital (NFLX): Netflix’s Man Overboard Moment
• TSOH Research (NFLX): The Greatest Opportunity in Entertainment ($)
• Meta Newsroom (FB): Next-Gen AI Supercomputer
• Value Situations (BG): Bunge Limited
• Stripe Newsroom (SPOT): Stripe & Spotify Partner to Help Creators
• Marketpulse (EBAY): eBay’s Aging Seller Population
• Stratechery (INTC): The Intel Split
Podcast of the Week
There is a huge range of Podcasts to listen to, and the choice can feel quite saturated at times. Here, I will share one podcast I listened to during the week, that I feel is worth your time.
Shrubbery Capital: What 15-Y in Hedge Funds Teaches You
This conversation with a 15-Y tenured hedge fund manager (Shrubbery Capital on Twitter) from December 2021 was great. Having worked for event-driven funds, family offices and pod shops, Shrub shares a swath of insights into the differences between each style of investing.
Topics covered include; merger arbitrage, becoming a portfolio manager, blowing up an account, structuring trades, finding ways to stay in the game, ESG, technical analysis, and his own recycling investment thesis.
Host: Brandon Beylo
The S&P 500’s first 16 days of the year was the….worst on record after losing 11% in that short space of time. Naturally, people were scared and there is a lot of schadenfreude being exhibited on the interwebs (which I don’t care for). Some are emerging from the woodwork and citing how obvious this fate was (with the benefit of hindsight of course).
Whilst individual stock picking appeared to be ‘easy’ across 2019 through early 2021, some are now realising that the tide which lifted them has now capsized them. Retail investors tend to buy the highs and sell the lows. Rather, they tend to buy when optimism is at all-time highs and sell when fear sweeps the market. We are humans, and this is how we are wired.
For someone to feel so bullish about Pinterest at $85, yet feel they are wrong at $26 is an interesting point. In theory, you should be elated, but in reality (and I suspect this has blighted many) it is likely said investors got caught up in the bull frenzy and overpaid for their businesses. I myself have been guilty of such actions too, I am not casting fingers. Instead of feeling deflated, an investor with a long time horizon should extract positives from these scenarios; better to learn these lessons now than in 10-years time. What separates an investor of 1-year versus an investor of 10-years? Ignoring the obvious variables, it’s the number of mistakes each investor has made. The tenured investor has made (and ideally learned from) a wide array of mistakes whilst the newly christened investor still has many to make. Volatility is part of the process. Last week, Ben Carlson crunched the numbers (1928 through 2021) and shared that the S&P 500 faces a correction (10%+ drawdown) on average every 2-years.
Whilst I find bottom timing an impossible task, buying at the most opportune moments (when r/r is perceived to be vastly favourable) seldom feels ‘good’. At these moments, there is a general reluctance from all market participants to take whatever opportunity you think is in front of you; contrary to moments of excessive exuberance, when most are frothing at the mouth to part ways with their cash on the way up. Terry Smith’s assertion is that one should buy quality, avoid overpaying, and do nothing. I think that’s great advice.
Lastly, a special dishonourable mention to President Joe Biden for this beautiful piece of chart crime. He states; “this didn’t happen by accident. Because of the actions we took, last year we achieved the fastest economic growth in nearly four decades”, totally ignoring the base rate effect.
Author of Investment Talk