I am Optimism Man

Our economy was firing on all cylinders in the last ten years and really picked up steam on the last few years. Stock gains were even stronger than the economy for three related reasons —

1. Capital / the cost of money // has been shockingly cheap by historical standards (which reduced the gains available in bonds),
2. The USA was the one economy that was doing great, with growing corporate earnings and confidence, while all of Europe and Asia were struggling, and
3. The basic reality of TINA (There Is No Alternative) had sunk in to anyone looking for yield greater than a few percent. PE’s expanded, making the market more expensive compared to historical averages, but not so much that it was considered as massively overvalued.

And then the black swan, in the form of COVID-19, hit us with an unprecedented torpedo: world-wide, businesses shuttered. Unemployment is skyrocketing (really really skyrocketing). The hangover that follows is a mystery. The end of worry and ramifications of COVID-19 are also a mystery. Markets don’t like above-average uncertainty and this is 500% above average uncertainty.

As a realistic optimist, I’ve always believed that things work out over time, and the most dire predictions are rarely, if ever, right. Dire predictions happen because fear intoxicates even the smartest of minds, usually because they are thinking too deep in the weeds. The proven truth is when the human race is focused, we often accomplish miracles. We are focused on this virus and breakthroughs are coming, even if the idea of weeks is a bit too optimistic. Biology is slower than breaking news on CNN.

Still, the markets try to anticipate and front-run the future. After the rapid plunge in March, markets have been incredibly resilient, climbing back into bull market territory during the month of April. I wonder if the confidence is justified. I question if this was sincere buying, or just the AI machines fueling a bounce.

The common sense best guess is that we will retest the recent lows. Most — not all — but most — rallies bounce and retest, bounce and retest. Very rare the V-shape bottom, but this time is a truly unprecedented economic event. The pre-Easter week roared upwardly in what looks to me a monster head-fake, but is it? Never has all of the world been shut down simultaneously. It seems likely to me that the markets will bounce for a while in a multi-W pattern before there is enough optimism to start the roar back. WwW before the upward / slope makes sense.

It is important to note that the background has changed a lot since the Great Recession. The world has embraced ETF’s in a much broader sense in recent years. This has resulting in greater-than-ever indiscriminate selling when people look to convert to cash. When there is a lot of selling in an ETF, the underlying automatic-trading systems sell the underlying shares, and we don’t see as much rotation from weaker issues to bellwether stalwarts as we might have in the past. We are “really” throwing out the baby with the bathwater because of large scale ETF investing.

Stock-picking individual issues is quickly making a comeback. Most of the companies on my shopping list are down significantly less than the S&P 500 is down, because canny investors have spotted the ETF dump-the-baby trend and are nibbling on the stocks with solid prospects, despite the economic malaise that 2020 is likely to become.

Still, if you know what your personal price levels are for a “good sale price” per stock, there is little reason to try to buy the absolute bottom because less than 1/10th of 1% actually get lucky and buy at the exact right time. I would rather not miss a great buying opportunity / price, versus wait and wait for a price that never comes.

I look at stocks as racehorses — and my money is the jockey in the saddle. I’m also a committed, realistic optimist. Barring a complete destruction of how capitalism and the monetary system, the stock market over a longer timeframe trends upwardly — see the chart of the market below which is the S&P 500 over my lifetime — recessions are a small portion of the overall lifetime to date:

The goal is simple but not easy — pick horses that will consistently outrun the overall pack / peloton of horses in the S&P 500 — and be alert to change horses when an opportunity arises.

In the meantime, cash held as cash, loses value — its purchasing power — at about 2% (recent decade) or more (in the past) per year. Inflation destroys the value of your savings, unless you invest it. Granted, this takes time (at 2%) so staying in cash when worried is not necessarily a bad move.

Over the longer term, investing in appreciating assets or companies is the only rational way to get ahead of inflation.

RE-GARP-UM-IT

I created my own personal formula / model / discipline for investing, called RE-GARP-UM-IT. It was created over 30 years, begging and borrowing from what I’ve learned. The acronym stands for:

R = Revenue (more specifically, growing organic revenue)
E = Earnings (more specifically, growing organic earnings)
GARP = Growth-At-a-Reasonable-Price
UM = Unique Moat (generally I want to invest in unique companies insulated from acute competition – acute competition hurts margins)
IT = Investment Thesis — a written two-three sentences as to why you are investing and what you expect to happen, so you know when to get out if it doesn’t actually come to fruition. If you don’t write it down, your memory changes over time.

I’ve always been a “Growth-At-a-Reasonable-Price” investor, commonly referred to as GARP. Adding to my GARP formula, I like to invest in companies that have a “unique moat” (UM) that makes threat of obsolescence from competition or immediate technology innovation hard to imagine. I’ve recently upgraded to add (RE). I think revenue needs to be growing, not just earnings, to avoid financial engineering like what IBM has done the last decade. Organic growth (revenue) is important (not just acquisitions growth or share repurchase growth). Lastly, I believe you must know your investment thesis (IT)… and always write it down, because pale ink is better than great memory.

RE-GARP-UM-IT.

It is important to stay disciplined to your own discipline (RE-GARP-UM-IT), and re-evaluate all your stocks every X number of months. If I had, I would have sold GE long ago, when organic growth went away — but that was a painful lesson in “pay attention to your own formula.”

In full disclosure, I am looking to add a Free Cash Flow component to my formula soon. But until then…

So what’s on my radar? To be clear, I’m expecting a retest of recent lows, although the market is now up more than 25% from the recent low — and the analysts are suddenly piling in to confirm that we have actually seen the low.

Here’s the short list of my top 10 and why —

#1: Microsoft.

IT: Up and coming competitor to AMZN in cloud computing (seems to be gaining share in a growing market) although AMZN has a truly large share (greater than 60%). Google, with all its might, does not seem to be gaining share like Softie. Companies are all moving to the cloud for enterprise computing in the next 5 – 10 years. Big & Rich. Huge staying power through a tough time.

Safety in uncharted waters: Unlike the other big techs, MSFT has managed to avoid the threat of “anti-monopoly” litigation by the US government. It seems like the US Gov will continue to pursue Big Tech and no one likes that uncertainty. It probably helps that MSFT was the bad-guy in monopolistic litigation a few decades ago.

UM: There is no great threat to Microsoft’s dominance of the Office Suite, even though Google has been trying for years with Docs, Sheets, and Drive. I have not seen percentages but it feels like a > 80% situation. Note to self – need to research on this.

REGARP: *** Note that earnings (which really matter to RP) are a huge question mark with worldwide economies basically shuttered ***

If you look at the chart below, MSFT has been blowing away the S&P 500. Yet its PE is mostly reasonable for the software industry at 26 and its PEG is a bit pricey at 2.06 (this of course changes with the current price, it is now 2.27) — but I think both these numbers will stay up at similar levels because of the safety and quality of the company’s financials. It is growing earnings at around 12% per year.

Here is the one page summary on MSFT.

Good price: Recent lows in the $130’s. Given the rotation from ETF’s to individual stock picking, I’d expect that even if the market re-tests the lows, MSFT will not see the $130’s but I’m buying at the next re-test, even if the price is around $150.

For short-term price finding, here is the 6 month chart:

#2: Adobe.

IT: Adobe is the one big show in software for creatives. They have successfully converted the business to annual subscriptions from license / upgrade / upgrade. Numbers have been on a roll.

UM: Adobe has competitors on individual fronts — for example Quark — but overall, they have done a great job of being the main game in town. Once you are great at Adobe, change it always hard. There is a distinct difficulty in changing tools.

REGARP: *** Note that earnings (which really matter to RP) are a huge question mark with worldwide economies basically shuttered ***

Growth at a reasonable price is a little hard as Adobe has been richly priced for a long time. I have wanted in but never puled the trigger. The PEG was down to 1.91 (now back to 2.62) and I don’t think it will see much lower.

Here is the one page summary on ADBE.

Good price: Recent lows are just below $280. I’m buying at the next re-test. I was hoping for a lot less than $300 but right now, I just hope that there is a re-test that gets ADBE below $305.

For short-term price finding, here is the 6 month chart:

#3: Facebook.

IT: Facebook is one of the most profitable companies in the world. They are better at unsolicited advertising than any other company on earth, including Google. Even if the government tries to break it up, it would break it up along product lines, which might actually result in three Facebooks and more value for investors.

UM: The network effect. Facebook and Instagram have nearly insurmountable leads because all your friends and family are on them already.

REGARP: *** Note that earnings (which really matter to RP) are a huge question mark with worldwide economies basically shuttered ***

Because the government has been looking to break up or at least reduce Facebook’s power, the stock has struggled for several years while earnings continue to grow quickly. The PEG was down to 1.02 (now back to 1.41) and that is incredible, given that everyone sitting around their home can’t be bad for using FB more.

Same as with Google, there is no doubt that online ads will take a hit — industries like travel and restaurants may take a while to come back. Earnings growth will be impacted, which will change the PEG. But for how long?

Here is the one page summary on FB.

Good price: Below $150. I’m buying at the next re-test.

For short-term price finding, here is the 6 month chart:

#4: Alibaba.

IT: There will be a day that trade with China will be fully in bloom again. BABA is the one Chinese blue chip that is in the middle of it all. And we should not forget that China is destined to become the economic center of the world in the next few decades. The one major worry that I have is that China is not exactly above interfering with the success of one of its own, and audited numbers there might not be as real as audited numbers are here.

UM: No other company is directly threatening Alibaba at this time. But it pays to pay attention.

REGARP: *** Note that earnings (which really matter to RP) are a huge question mark with worldwide economies basically shuttered ***

BABA has been growing like a weed. In the trailing year, BABA grew earnings 145.61% while revenue grew 35.66% The PEG is low at 1.09. All these numbers are great… unless a fresh trade war breaks out between the US and China after Trump blames China for biology.

Here is the one page summary on BABA.

Good price: At or below $180. But I have to get over my fear of being far far away and not being as able to watch BABA on the streets of China. It really is hard to invest when you have zero feel for the company on a day to day basis.

For short-term price finding, here is the 6 month chart:

#5: Google

IT: Google has no challenger to search. Its core business (advertising based on search) is very safe and has been a steady 20% grower, even though Facebook and others are fighting for their share of ad dollars. Advertising effectiveness online is much easier to measure and therefore justify than advertising without measured effects (like TV and Billboards).

Additionally, the youtube business doesn’t have a direct challenger, although it is not as much of a total dominant space as search. As the world goes more and more online, whether from work or from home, there is no stopping this train. Additionally, it seems that soon, one of the multitude of innovative bets is likely to work and move the needle.

UM: See above. There is no challenger to search worldwide, except for China where Google does not play. Google has a stellar moat.

REGARP: Both revenue and earnings have been growing right around 20%. Yet GOOGL has a PE of 26 and a PEG of 1.68 which seem reasonable given the immense cash hoard, the great profitability, and the awesome growth rate.

Same as with Facebook, there is no doubt that online ads will take a hit — industries like travel and restaurants may take a while to come back. Earnings growth will be impacted, which will change the PEG. But for how long?

Here is the one page summary on GOOGL.

Good Price: At or below $1,100, but we might not see that level given the recent positive (resilient) earnings announcement.

For short-term price finding, here is the 6 month chart:

#6: Taiwan Semiconductor.

IT: TSM is the largest contract semi-conductor maker / fab company on earth. Fabs cost so much to build that the majority of semiconductor chips are now built at a contract foundry, and that trend will continue into perpetuity. My thesis is that the 5G conversion will drive a large amount of volume in the next few years.

UM: The sheer cost of building a new fab is a very effective moat for TSM.

REGARP: TSM’s PEG has been near 1.0 at 1.18 (source is Ameritrade) which is very attractive. Hmmm… I just noticed a remarkably different PEG at gurufocus, which now makes me wonder as to why there is such a wide discrepancy. Here are the Zacks numbers, and they are different too. (note to self — investigate why the estimates are so wildly different). FCF is not nearly as smooth as other companies, because TSM is in one of the most capital intensive industries in the world. Additionally, RE growth is lower than most of the companies I target, but I really like the lack of competition and the “swelling tide” of chips all over the world.

Here is the one page summary on TSM.

Good Price: Unlike a lot of my other targets, TSM does not have a strong retail following. Therefore, it is more likely to test recent March lows in the mid 40’s.

For short-term price finding, here is the 3 month chart:

#7: Amazon

IT: COVID will make AMZN stronger than ever. Scaling up to meet the demand is a challenge. But that’s a good problem to have.

UM: No one is close to AMZN in online retail.

REGARP: To be clear, this is NOT A “RP” stock. Amazon has an amazing leader in Jeff Bezos who is the pied piper of Wall Street. He has convinced the Street that profits don’t matter as long as growth is extraordinary. I can’t build a case for AMZN value at a specific price because earnings come and go with the winds of huge capital expenditures, but the Street breaks the rules and plays along with Mr. Bezos.

Here is the one page summary on AMZN.

Here’s the bottom line. AMZN is not a GARP stock. I can’t justify it based on my formula. The question is do I purchase it on an exception basis because I believe COVID will be an incredible windfall for the company.

Good Price: Under $1800, but the train may have permanently left the station and I may not get a second chance.

For short-term price finding, here is the 6 month chart:

#8: lululemon athletica.

IT: LULU has a lock on casual athletic wear with upscale females. Although many are trying, LULU still maintains a lock on being the best, the one that everyone wants.

UM: The moat is not as strong as I would normally invest in. Nike, Adidas, even UA all want this business, and they are bigger than LULU. I will have to spot warning signs quickly if trends turn against LULU.

REGARP: LULU is another stock that challenges my thinking on GARP. LULU has recently approach a PEG of 2.0 and currently sits at 2.2. As a retailer, they are hard hit with store closures but have a better online presence than many retailers. They have a lot of cash and negligible debt, so odds are better than average that they can ride out the storm.

Here is the one page summary on LULU.

Good Price: Below $160.

For short-term price finding, here is the 3 month chart:

#9: Qualcomm.

IT: This is a bet on a ‘bad times behind us // time for a turnaround’ kind of play. QCOM has massive patents to basically ensure QCOM content with the rollout of 5G. 5G will rollout, COVID or no COVID. Hard to imagine how this company does worse than the S&P 500… but they have been held back in recent years by litigation with Apple and other company patent infringement in China. Both these issues seem to be mostly in the rear-view mirror, although Trump keeps rattling the sabre with China.

UM: Patents patents patents.

REGARP: QCOM seems a good value with a PEG of 1.2. Of course, all this assumes that the world recovers from COVID in 6 – 9 months, not 6 – 9 years.

Here is the one page summary on QCOM.

Good Price: In the lower $60’s. Note that QCOM pays a decent dividend rate at that price too. Note the recent years of underperforming the S&P. I wonder if the 5G years will help it vault ahead of the S&P.

For short-term price finding, here is the 6 month chart:

#10: Starbucks.

IT: Starbucks is the ongoing “pub” of the next decade. Having suffered in a sideways pattern for a year years, it seems spring loaded to catch back up to the S&P. That said, COVID is an overhang for any business that thrives on people in a social setting.

UM: No one close. And it would take decades for someone to catch up.

REGARP: SBUX might be overvalued at a PEG of 1.99, given the overall environment. The 60% gap between revenue and earnings growth is a bit concerning as well.

Here is the one page summary on SBUX

Good Price: Still, if it revisits the mid-50’s, I think the spring loaded reality still exists. Note the outperform to the S&P in the last year plus. SBUX over its life has sported a PE significantly above the market, not at the market.

For short-term price finding, here is the 6 month chart:

#11: Visa.

IT: Steadily, society is reducing the use of cash and checks in favor of electronic payments. This lifts all the companies in the cash-less world, from Paypal to Paypal’s Venmo to Zelle to the more traditional Mastercard and Visa. Since the S&P tracks the economy, it makes complete sense that Visa should track the economy plus gain from the trend away from cash, and therefore grow faster (assuming that you bought it at a fair price).

UM: Visa is the 800-lb gorilla in the room. Any market change will be slow and noticeable.

REGARP: I have wanted in on Visa for several years but it always looked richly valued. Now that the economy is in question, Visa is significantly cheaper — if and only if the economy does recover relatively soon. Unfortunately, I may have missed the moment when V was at a discount.

Here is the one page summary on V.

Good Price: Below $150.

For short-term price finding, here is the 6 month chart:

#12: Bidu.

IT: This is a TURNAROUND bet — a company with continuing revenue growth but difficulties turning it into earnings growth. BIDU is the closest thing to Google in China, the country that will not stop growing and becoming a great economic powerhouse this century. They have struggled with turning that position into steady, improving earning however.

UM: Several other monster companies — Tencent, BABA, JD — all want a piece of the action, and how things work in China (people are more mobile, the bigs lock you into their ecosystem, payments via messaging) seems to have made BIDU’s moat not as effective as Google’s is around the rest of the world.

REGARP: BIDU (if you trust Chinese accounting and audit) is fairly cheap and has had several years of underperformance. But, a worry is that its PEG ratio is not lower than this — which I would expect to find for a company that has not gained market respect in recent years.

Here is the one page summary on BIDU.

Good Price: Below $90.

For short-term price finding, here is the 6 month chart:

So what about Apple?

IT: 5G will drive a super-upgrade cycle. But will Apple gain share? I was an AAPL investor for nearly 10 years and have enjoyed great gains, but they shook me when they decided to dramatically reduce transparency of iPhone sales. It seemed like a great admission that the core product was no longer gaining share at all, the numbers perhaps plateauing, and that they would have to focus on everything else to prop up results.

UM: No one competes effectively against Apple at the high-end of smartphones, smart watches, laptops. It has more cash than nearly anyone. Services keeps growing.

REGARP: Apple’s PEG has grow from near 1 to over 2. It is becoming less of a value. This worries me — the trend is a negative — although other stocks above are also above 2. But, when I compare AAPL to MSFT for example, the trend seems to be MSFT’s friend (the move to cloud and MSFT gaining share in cloud enterprise computing) while its harder to see what trend will be AAPL’s friend right now (5G?).

Here is the one page summary on AAPL.

Good Price: Near the lows from March (maybe). Still doesn’t feel cheap enough.

For short-term price finding, here is the 6 month chart:

The Bottom Line

The bottom line is that’s my investment opportunity radar, and roughly the prices I hope to see again in 2020. Time will tell how this plays out. I may have missed a great buying opportunity but V bottoms are rare, and if something spooks the market, the ETF reality **should** once again discount the baby with the bathwater.

It helps to think on paper. Writing it down takes hours of work, but I find that I walk away with a better understanding and clearer thinking of my plan. For example, I still own small positions in Schlumberger and Alaska Airlines — and I really wonder why I rode those all the way down. It is hard to see how those horses can possibly even come close to average in the next few years.

I.M. Optimism Man