December 2021 Newsletter
"The true?investor welcomes volatility...a wildly fluctuating market means that irrationally?low prices will be periodically?attached to solid businesses"?- Warren Buffett
Dear Readers,
We've usually started?our?newsletters off with a quote from Warren Buffett or Charlie Munger as we've done our best to learn and employ the philosophy?and tactics that made them (and many other value investors) so successful. At a high level, this has resulted in using the following value-oriented?approach:?
And while this process seems exceedingly simple, it's very difficult for most to follow. High concentration leads to higher volatility, potential investor drawdowns, and periodic underperformance when compared to a broadly diversified portfolio. However,?as history shows, that is the price you pay for performance and creation of wealth.
We've found that most of?the investing world equates risk to volatility.?We do not. To us, we've always defined risk as Charlie Munger has: it is either the permanent loss of capital or the chances of an inadequate return. Volatility is not a concern, which is why we?have several stocks that have close to 10% allocation - quite unusual?in the investing world. Many pundits would say that our strategy is riskier than that of conventional investors. Not only do we disagree, but we believe the opposite.?
Concentrating on a few businesses we understand very well should decrease risk, not increase it. We're highlighting this concept to explain the volatility of our portfolio over the last few months. The Omicron variant, inflation concerns and supply chain bottlenecks have certainly not helped and have caused massive uncertainty in the short-term, but they have not materially impacted the businesses we're investing in for the long-term. In some cases, we've even taken the opportunity to buy more stock at cheaper prices.?
Another differentiator worth noting is that we gather our own information and make decisions based on the facts that we've gathered ourselves. Investing is more of an emotional than intellectual exercise. It?becomes difficult to stay on an even keel and to make?rational, unbiased judgments if you’re making them based on someone else’s information. This is not to say that we don't read other opinions because we do, but only after we feel that we fully understand the economic characteristics of the businesses we're considering. Only then do we factor in outside research to stress-test our own assertions. At times, this may make it daunting to some?as we may be investing in companies that are quite unpopular. But we've done our due diligence on each business we own and our portfolio weight is commensurate?with our conviction in each.?
Moving on to our portfolio, I'm happy to report that the?2021 average client return was 25.89%?(as of Friday's close) compared to 21.39% of the NASDAQ, 18.92% of the DJIA and 26.89% of the S&P 500. Yes, we marginally underperformed?the S&P 500 for the year, but it's important to note that we had outperformed the index until the very last day (and had outperformed it in 2020). Again, our approach of owning a smaller number of high-quality businesses will result in higher volatility and periods of underperformance...but we are confident that we will outperform the market over time.?
Biggest Gainers:
CVS Health Corp (Ticker: CVS)?- Management has made a concerted effort to pay down its debt, while it continues growing its online pharmacy presence, employing stores with Minute Clinics, and offering services via Aetna (3rd largest healthcare provider in the U.S.), which has allowed the company to generate approximately $13 billion in free cash flow every year. CVS distinguishes itself as it becomes a one-stop-shop for healthcare. And while retail pharmacies have struggled with reimbursement and competitive pressure. CVS’ management recognized these challenges relatively early and reinforced the company’s competitive position through vertical integration, including the acquisitions of pharmacy benefit manager Caremark and managed-care organization Aetna. We don’t expect much net income growth from CVS, but we believe a double-digit free cash flow yield can still provide an acceptable total return.
Nvidia Corp (Ticker:?NVDA)?- The company is a supplier of chips for everything from mining cryptocurrency to performing artificial intelligence tasks to playing video games (3 markets which will continue to see massive growth). More recently, it has rallied because investors believe it will prove a “metaverse platform enabler" with its new Omniverse Enterprise platform.?It is a pioneer of what is known today as a graphics processing unit (GPU) and, over the years, management has taken an aggressive approach to continually transforming itself as required by the industry needs and trends of the time. Last Quarter, the company's total revenues of $5.66 billion beat street expectations by $266 million, growing 84% (including the benefit of acquisitions, 65% organic), with its gaming business growing over 100% and its data center business expanding nearly 80%. We remain confident in NVIDIA’s leading position in gaming, data centers, autonomous machines and now the omniverse (with its platform already having 500+ corporations evaluating it).
领英推荐
Alphabet Inc Class A (Ticker: GOOG)?-?Alphabet has a mixed record of execution, in our opinion, with a few brilliant moves counterbalanced by wasteful spending and half-hearted new product launches. However, growth and margin expansion have accelerated in recent quarters, renewing our faith in management. Opening Google Shopping to unpaid listings seems to be making the search engine a top destination for e-commerce again, and the company’s best-in-class first-party data should help it navigate privacy changes on Apple’s iOS.
Lumen?Technologies Inc. (Ticker:?LUMN)?-?Last quarter, the company reported growth in its large enterprise and international segments on a sequential basis, suggesting things may be turning a corner. The company also raised its free cash flow guidance for the year from a range of $3.1 billion to $3.3 billion, to a range of $3.6 billion to $3.8 billion, as a result of more efficient capital expenditures this year. More surprising was that the company bought back stock for the first time in recent memory. Actually, it bought a lot of stock: about $1 billion, or nearly all of its quarterly free cash flow. Due to the company's low valuation, that was good enough to reduce shares outstanding by about 7%. Perhaps most importantly, management also reiterated it would be maintaining its dividend while still investing for growth. And despite the recent rally, the stock is undoubtedly cheap at just over four times free cash flow so we still see considerable upside.
Biggest losers
If you invest for long enough, you will always have both winners and losers in your portfolio, which is why having a margin of safety and diversifying across the different asset classes (e.g.?stocks, bonds, commodities) is so important. I am no exception to this rule. However, as my winners outpaced my underperformers, I'm still happy with the performance of the portfolio as a whole.???
DraftKings Inc. (Ticker:?DKNG)?-?The stock is off from $71.98 on March 19 to $27.47 as of Friday's?close. That represents a drop of 37.8% over the last year. However, there were a lot of bright spots in DraftKings Q1 earnings report, which showed that revenue rose 253% over Q1 2020. More importantly, the company pointed out that the average revenue per customer had risen 48% for the same period last year, meaning customers are more engaged. On top of this, the company expects that more states will continue to legalize online gambling, bringing in more customers and revenue.?
There has been a huge shift in states’ attitudes towards sports betting since the U.S. Supreme Court made it legal in 2018. According to most industry analysts, sports betting could reach $15 billion in 2025, way up from $3 billion in 2020. And that doesn’t even include other gaming activities that could expand the online gambling market even further DraftKings raised its revenue to over $1 billion, giving it at least a one-third market share in the U.S. We can use this to estimate revenue growth by 2025. If DraftKings attains 20% market share by 2025, revenue would be $3 billion.?
This works out to an average annual growth rate of 73.2 % per year on a compound basis. It would likely make $1 billion in other online gambling revenue. DraftKings is currently unprofitable, losing 36 cents per share in Q1. But this is mainly due to much higher marketing expenses, which rose to 73.2% of sales in Q1 2021 on much higher revenue. As a result, by 2025 I expect that marketing expenses will be much lower as a percent of sales.?
Note: We decided to sell this position (along with SPLK) in December for tax reasons (this will help to minimize our clients' tax bill by offsetting short-term capital gains). It is our intent to buy back this stock in January after 30 calendar days from the date of sale have passed (to prevent the wash rule from taking effect).?
StoneCo LTD (Ticker: STNE) -??Shares of StoneCo are down about 34% since the company announced third-quarter results that missed analysts' earnings estimates. We believe investors were concerned about increased funding costs, the cost of investment initiatives, increased competition, and the integration software provider Linx. Stone provides Brazilian micro-, small- and medium-sized merchants with payments and software solutions. Essentially, they are the Square of Brazil with a huge runway for growth. Investing in emerging markets is not for everyone. A stock price pullback can be a blessing in disguise, though investors will obviously have to decide for themselves if that's the case, with StoneCo.?
The extra layer of risk isn't just from the emerging market itself -- there is bound to be more uncertainty on the part of international investors, making them susceptible to getting spooked more easily, adding further to the volatility, versus a North American stock. StoneCo's credit product issues and reduced margins have provided just the fodder for investor anxieties. But underlying some of StoneCo's short-term operational weakness has been management's deliberate intent to pursue long-term growth and bigger scale. For U.S.-based companies, this would often be met with investor enthusiasm. It could take some fortitude to navigate the volatility, but it looks like StoneCo still presents an opportunity for the long-term oriented investor.?
Alibaba Group Holding Ltd - ADR (Ticker: BABA) -?It's been an interesting few months for this stock, which has seen a decline of 47.12% over the last year. There is definitely more risk to factor in due to the Chinese crackdown/Evergrande situation, but overall we still believe the shares present an opportunity for capital appreciation as the firm has a strong balance seen and is still experiencing massive growth. We also believe China's goal is to become the largest global economic superpower, and they were just flexing their muscles with the recent crackdowns. As China's economy continues to expand, we believe Alibaba will be a direct beneficiary. Additionally, the recent buyback increase of 50% signals that management has tremendous confidence in their long-term business model.
I hope you found this publication useful, and that you’ll take some time in the coming weeks to review your current investments. If you have any other questions, then please review the?attached document and or feel?free to reach out directly. We’d love to hear from you and answer any of your questions in our next newsletter.?
For more information on?Sirmium?Capital, visit our website at?www.sirmiumcapital.com