Unicorn or Incumbent?

Which is better, a sparkly new unicorn company, or a tried and true incumbent? Microsoft went public in 1986, and the stock went for an adjusted $0.12/share – today it trades for $304. My calculator seized up when I tried to determine the percentage gain. We all wish we had sniffed out how successful this once-unicorn would become. On the flip side, I remember the day in early 2000 when pets.com, a glitzy but unprofitable company with a stratospheric valuation, went public. Pets.com went out of business later that year, and became a symbol of how ridiculous the technology space had become, riddled with young, unprofitable, poorly run companies. The list of long-standing companies, however, that have gone bankrupt or even completely out of business is also long – Lehman Brothers and Kodak come quickly to mind. But some of the best performance returns still come from well-established companies. We hold several stocks with dizzying 5-year total returns: Lam Research +594%, Applied Materials +425%, Estee Lauder +354%, and United Health +212%. So what’s an investor to do – seek out the next colorful unicorn, or find a well-run growth company with a proven track record?

The transition to more clean energy is not a fleeting trend, but here to stay, and has good examples of both unicorns and incumbents. Last quarter Tesla, which finally posted a profit in 2020, generated $13.8 billion in revenue, while Ford generated $35.7 billion. Ford manufactured its first car in 1903, and Tesla produced its first car over a hundred years later in 2009. Notably, they are the only two American automakers that have avoided bankruptcy. Both are pioneers: Ford introduced the moving assembly line which increased production levels, while Tesla similarly pioneered electric vehicle production. Both companies inaugurated mass-market vehicle availability for the middle class. Henry Ford, who had previously worked for Thomas Edison, made an electric vehicle in 1901. But it took Tesla nipping at their heels over a hundred years later to push Ford into the mass-market electric vehicle space. Today, you can buy a pretty cool electrified Mustang Mach or F-150 truck.

The young, innovative energy of unicorns is perfectly married with the knowledge and experience of incumbents. The synergies created by these competitive connections are amazing as they each push for improvement. Both face the daunting challenge of achieving sustainable business models and profitability. And as Elon Musk says, “prototypes are easy, production is hard, and being cash-flow positive is excruciating.” There are many ways to succeed as an investor, but I believe that companies with little or no debt, good earnings growth, and rock-solid cash-flow, perform better over time. And all of these companies initially started out as unicorns, so it is best to remain open minded!

By the way, Merrill Lynch was the lead underwriter for pets.com, and their analysts maintained a buy rating throughout 2000 as the stock tumbled. It was a conflict of interest for sure, and another good reminder to consider the source of information about stocks, because often it is driven by marketing and is not good investment advice.

Sources: Refinitiv, https://www.thehenryford.org/

Smart Stock Stats for Holiday Party Conversations

Happy Holidays!  It is an exciting time to be an investor, and 2022 is setting up to be another good year in the stock market.  Many of you have told me that you are weary of discussions about Covid and politics, so I thought it would be fun to share some quick facts to enliven your holiday conversations:

  • Only 13 companies in the S&P 500 have zero debt – some of you own stock in Arista Networks and Ulta Beauty, 2 of the 13. 💳
  • Only 55 companies in the S&P 500 have 5-year earnings growth over 25% – some of you own Applied Materials, Arista Networks, Hologic Inc., Lam Research Corp., and Regeneron Pharmaceuticals Inc., 5 of the 55. 🏁
  • The New York Stock Exchange originated in 1792, but the oldest recorded exchange dates back to 1611 in Amsterdam where just one company traded, The Dutch East India Company.  ⛵
  • In 1967, Muriel Siebert became the first woman to purchase a seat on the New York Stock Exchange – she remained the only woman for another 10 years.  👵
  • The NASDAQ exchange was the first decentralized network of firms trading stock, originating in 1971.  🖥
  • The first brokerage firm to offer touch-tone phone stock trading was Charles Schwab (my alma mater) in 1989, and the first to offer internet stock trading was K. Aufhauser & Co. in 1994.  ☎
  • In the 1890’s, new innovation made bicycle production and affordability soar in Great Britain, and about 700 new publicly traded bike companies emerged with soaring stock prices.  The mania fizzled, and investors lost an average of -71%.  🚲
  • 55% of publicly traded companies in the world are based in the United States, with Japan coming in second at 7%.  The Taiwan stock market has the best investment performance for 2021.  🌎

Through November, the Pawleys Dividend stocks were up about +25%, walloping the Dow (up 14%) by +11%.  That means for every $100,000 invested, you made an extra $10,000 or so after expenses, versus an index mutual fund.  Index funds may be low cost, but you end up owning stocks of companies with high debt and poor earnings, which drags down performance in the long run.  The more aggressive Pawleys Growth stocks were up +29% versus 23% for the S&P 500, beating by over +6%.  I don’t always beat the market, but by keeping a cool head, systematically rebalancing portfolios, and picking stocks of companies with little or no debt, good earnings growth, and rock-solid cash flow, we tend to do better more often than not.
Happy Holidays and please let me know if you learn any more fun stock stats, I love hearing what is on everyone’s mind!

Sharpening our Pencils for 2022

The Covid induced shutdowns of last year created lots of “noisiness” in corporate earnings, which made for many long nights evaluating the financials of stocks. But as we prepare for 2022, the work will not be any easier. This week markets were rightfully rattled by the financial breakdown and potential default of Evergrand, one of the largest real estate developers in China. The Chinese government has since guided local governments to prepare for unrest, as the company has missed paying staff and suppliers, and an estimated 1.5 million home-buyers may not receive their finished houses. Here in the U.S., Federal Reserve Chair Jerome Powell stated that Wells Fargo will continue to be subject to asset caps limiting their lending until they shore-up operational procedures and governance. The White House has proposed the “Chips for America Act” to address semiconductor shortages caused by plant shut-downs in Asia due to Covid outbreaks, while the global supply chain continues to face delays caused by port and shipping staffing problems related to Covid. Despite these challenges, the Leading Economic Indicators continue to rise, and the U.S. Treasury yield curve remains upward sloping, both suggesting that the economy will be solid 6-12 months in the future. So why do we need to sharpen our pencils?

Earnings will likely grow at a slower rate in 2022, so stock selection will be critical to achieving good investment performance while mitigating portfolio risk. Over-valued darlings will fall with even nominal earnings misses. This month, we took a quick dive into the overall financial health of the S&P 500. The average debt:equity ratio, which expresses how much debt a company holds versus its value, sits at 1.98, so they owe twice the value of the company. Imagine owning a home worth $400,000 and owing $800,000 on it! There are only 18 companies with zero debt. There are 90 companies with negative earnings growth (trailing 5-year earnings per share), and only 50 have growth over +25%. The average price:earnings ratio is around 35, showing that any slowing of earnings in 2022 will likely cause weaker stocks to falter. It is so important to not over-pay for earnings streams when the possibility of slower growth rates is likely.

Yes, I still use a pencil and Texas Instrument BAII Plus calculator from time to time – but in reality, we will be burning the midnight oil on Excel as we prepare the Pawleys Dividend Fund and Pawleys Growth Fund for 2022. Constructing a well-thought-out portfolio with stocks of companies with little or no debt, good earnings growth, and rock-solid cash flow will be even more important as we enter 2022. This discipline and balance, in my opinion, positions portfolios to perform well in a myriad of economic conditions while achieving built-in risk management.

Sources: Reuters, Refinitiv, yCharts, Conference Board