Category: General Investing

Last week, many US-listed companies started reported results for the first quarter of 2021. Here are highlights from some of the companies I have a vested interest in, through the investment fund I co-founded, that reported this week.

Tractor Supply Company (NASDAQ: TSCO)

The US retail chain focusing on the “out here” lifestyle started the year on a strong footing. Comparable sales increased by a staggering 38.6%, the result of traffic growth of 21% and average ticket size growth of 17.6%. The latter was driven by sales of big-ticket items such as safes, fencing, and utility vehicles. Diluted earnings per share (EPS) was up by 118% to US$1.55. And the company is now projecting full-year diluted EPS for 2021 of between US$7.05 and US$7.40, a step up from previous guidance of US$6.5o-US$6.90, and from US$6.38 in 2020.

During Tractor Supply’s earnings call for the latest results, CEO Hal Lawton highlighted increasing millennial home-ownership, migration to urban areas, and greater pet adoption as long-term trends that will benefit Tractor Supply. He said:

“Over the last 12 months, we’ve seen a 400 basis point shift in the customer age cohorts of 18 to 45 years old. This demographic has long resisted many of the traditional generational norms, things like household formation and homeownership. But the pandemic has shocked this generation and accelerated their embracement of these types of activities. There continues to be a net migration out of urban areas largely driven by the millennial segment.

The most robust homeownership growth is in the millennial cohort, with the growth coming in suburban and rural areas. We believe growth in this customer segment has staying power and could be a structural game changer for us.

Another structural customer trend that is working to our advantage is the significant increase in pet-owning households and number of pets adopted. Compared to the overall U.S. household pet ownership of approximately 2/3, our customers over-index in pet ownership by about 10 points. And our current survey work with our customers indicate 25% have recently acquired and adopted a new pet. New companion animal ownership acts as an annuity for our business as these puppies and kittens grow up and have growing life cycle needs. We’re also uniquely positioned to offer a growing menu of services such as pet wash, vet clinics, prescriptions and tele-vet services.

Whether it’s more food, treats, toys, containment and more, the humanization of pet provides us with future opportunities for growth. These customer trends are an indication that we continue to benefit from the numerous tailwinds such as pet ownership, the millennial urban exodus, backyard poultry, homesteading and home as an oasis. We believe many of these consumer trends will be enduring shifts well into the future. Our brand momentum is stronger than ever, and we’re investing to ensure we continue to play offence in the context of these trends. We are making excellent progress on our Life Out Here strategy and initiatives.”

Intuitive Surgical Inc (NASDAQ: ISRG)

The robotic surgery company which manufactures and sells the da Vinci brand of robotic surgical systems also had a strong start to 2021.

New system placements increased by 26% year on year from 237 to 298 and the installed base of da Vinci systems grew by 8% from the first quarter of 2020 to 6,142. Worldwide da Vinci procedures grew by 16%. Revenue was up 18% to US$1.29 billion and net income surged 36% to US$426 million, with diluted EPS up 34% to US$3.51. With 2020 procedure growth coming in at just 1% due to the COVID-19 pandemic, the company anticipates a swift rebound in 2021 with full-year procedure growth of between 22 and 26%.

As COVID-19 infections begin to subside in parts of the world, more non-emergency surgeries which were postponed due to the pandemic will eventually have to be performed.

Gary Guthart, Intuitive Surgical’s CEO, is bullish on the impact of the company’s two new platforms (Da Vinci SP and Ion), and the rebound in business as COVID numbers decline. He said the following in Intuitive Surgical’s 2021 first-quarter earnings call:

“We’re in the early innings of commercialization of two new platforms for Intuitive while advancing digital enablement of our ecosystem. Our teams are making good progress in all three areas. Overall, we’re seeing some pandemic recovery, but improvement has been uneven with significant regional variation. Our experience shows that our business rebounds as COVID drops…

…Overall, capital strength indicates anticipation of future procedure opportunity by our customers. A significant number of systems were part of multisystem deals by hospitals and integrated delivery networks, supporting a theme in which customers who know robotic-assisted surgery well continue to invest with us.”

Chipotle Mexican Grill, Inc (NYSE: CMG)

The Mexican fast-casual food chain was off to a promising start in 2021. Revenue was up 23.4% to US$1.7 billion, driven by staggering comparable restaurants sales growth of 17.2%. The company’s restaurant-level operating margins improved by 4.7 percentage points from a year ago to 22.3%. Digital sales were up 133.9% and the company opened 40 new restaurants during the quarter, bringing its total to 2,764. All these helped bring adjusted diluted EPS to US$5.36, up 74% from a year ago.

As Chipotle laps pandemic-induced closures last year in the second quarter of 2021, it expects comparable restaurant sales to be high in the range of high-20s to 30%.

The long-term outlook for Chipotle looks promising too. During Chipotle’s 2021 first-quarter earnings call, Brian Niccol, who became the company’s CEO in 2018, described some of the company’s strategies to achieve its long-term goals of having more than 6,000 restaurants, average unit volume (revenue per restaurant) of more than US$2.5 million, and a restaurant-level operating margin of more than 25%. He commented:

“These are one, making the brand visible, relevant and loved. Two, utilizing a disciplined approach to creativity and innovation. Three, leveraging digital capabilities to drive productivity and expand access, convenience and engagement. Four, engaging with customers through our loyalty program. And five, running successful restaurants with a strong culture that provides delicious food with integrity while delivering exceptional in-restaurant and digital experiences.”

Netflix Inc (NASDAQ: NFLX)

It was a mixed bag of results in the first quarter of 2021 for global streaming giant Netflix. Although revenue was up 24% from a year ago to US$7.16 billion, the company only added 4 million global net new subscribers during the quarter – 2 million below analyst expectations – bringing the total to 208 million. The company also forecasts just 1 million net new subscribers in the second quarter. According to Netflix’s management, there were two reasons for this. First, there was pull-forward of new subscribers in 2020 due to COVID-induced shelter-in-place measures, and second, there was the delays in the release of hit programs due to production pauses (again because of COVID-19). Nevertheless, I think the long-term growth story remains intact.

And on a bright note, the company was free cash flow positive in the quarter, producing US$692 million, up significantly from US$162 million a year ago. Netflix also announced that it will be buying back shares and said it is on track to be free-cash-flow neutral this year and positive in the years ahead.

Ted Sarandos, Netflix’s co-CEO and chief content officer, explained in the latest earnings call why he thinks subscriber growth should return in the latter half of the year. He said:

“And we think we’ll get back to a much steadier state in the back half of the year and certainly in Q4 where we’ve got the returning seasons of some of our most popular shows like The Witcher, You, and Cobra Kai as well as a big temple movie that came to market a little slower than we’d hope like Red Notice with The Rock and Ryan Reynolds and Gal Gadot and Escape from Spiderhead with Chris Hemsworth, a big event content. Now, all that being said, in every quarter of the year, we release more content than we did in the previous quarter and in the previous year quarter by quarter and every — in every region. It’s just that I think the shape of the mix of the content is, you know, become a little more uncertain, and then the long-term impacts of the corporate shutdown are also becoming a little more uncertain in that — in that timeframe in the first half of this year.”

Reed Hastings, co-CEO and co-founder, added that despite the slowing net adds, Netflix still has a long runway to grow into. He mentioned:

“So outside of China, I think, pay television peaked about 800 million households. So you know, lots of room, and that was several years ago that at peak, lots of room to grow.”

ASML Holding NV (NASDAQ: ASML)

The supplier of lithography machines to semiconductor manufacturers extended its recent run of fine results.

During the first quarter of 2021, revenue was up 78% to €4.4 billion. Net income growth was even more impressive at 240% to €1.1 billion. In the quarter, ASML also repurchased 3.5 million shares. The undisputed leader in lithography expects overall revenue in 2021 to be 30% higher compared to 2020, when there was already healthy growth of 18%.

ASML CEO Peter Wennink believes that the company is benefiting from cyclical semiconductor demand in 2021 due to COVID-disruptions in 2020. At the same time, there is a long-term secular trend that should benefit ASML too. He shared the following in a video interview on the company’s 2021 first-quarter results:

“I would like to separate the growth profile into three trends. One trend is more a cyclical trend. 2020 – the COVID year- was really a year where also customers were cautious. Looking back, too cautious. So that underspend you could call is now translating into demand for 2021. Of course, that will take some time before we have our output done. So second half will be indeed higher and that trend you could argue should go away or should taper off in 2022.

There is a second trend. That’s a secular trend, the underlying trend. I think it is the continuous innovation and the drive for innovation driven by the rollout of 5G, its artificial intelligence, its High-Performance Computing. That underlying trend is the digital transformation. We see it everywhere. Leading to distributed computing. That will be there for years to come. That trend will also lead to higher demand for semiconductors and for our equipment. Which is one of the reasons why we’re stepping up our capacity.

He also mentioned a third long-term driver which is governments wanting their own countries to be able to produce semiconductors independently. This could be a blow to major foundries such as Taiwan Semiconductor Manufacturing Company, but will open the door for other companies to manufacture for their country’s needs. Wennink explained:

“The third trend is driven by the geopolitical situation which actually leads to major regions looking for technological sovereignty. Basically being able to be self-sufficient when it comes to electronics and semiconductors. We’ve seen announcements, governments, but also companies, focusing on expanding capacity. In the US, there are significant talks in Europe, in Asia. Well, that will lead to higher capital intensity because it’s decoupling as a worldwide eco-system. But it also leads to some capital inefficiency. Well there is a beneficiary of that capital inefficiency and that’s us.“

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Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in the shares of ASML, Chipotle Mexican Grill, Intuitive Surgical, Netflix, and Tractor Supply. Holdings are subject to change at any time.

Recently, there has been a flurry of activity in the Singapore stock market. 

In early March, Jardine Matheson Holdings Ltd (SGX: J36) announced that it would acquire the remaining 15% of Jardine Strategic Holdings Ltd (SGX: J37) it did not already own at a proposed acquisition value of US$5.5 billion.

And just a few weeks later, local property giant CapitaLand Limited (SGX: C31) announced that it was proposing to restructure itself by privatising its development arm while keeping its investment management arm public. 

Although both deals were offered at a premium to their respective “last trading prices”, shareholders of the acquired companies will still receive less than the net asset value of their respective companies.

Jardine Strategic is being acquired at a 19% discount to the value of its listed assets while shareholders of CapitaLand are receiving 0.08 units of CapitaLand Integrated Commercial Trust (SGX: C38U) and S$0.951 in cash for the development arm of CapitaLand, which translates to a 5% discount to its actual net asset value.

Fertile hunting ground?

These bring us to the question- is there likely going to be more privatisation offers in Singapore?

The two companies being acquired/restructured are just two of numerous companies in Singapore that are trading at discounts to their book value. 

With Singapore stocks trading at depressed valuations, even if acquirers offer a premium to a stock’s last trading prices, they may still be able to obtain their target assets at a hefty discount to book value.

This could make the Singapore stock market the perfect hunting ground for acquirers who are looking to buy companies at a cheap price.

This is exacerbated by the Singapore stock market’s failure to recover to pre-COVID levels. The Business Times reported that there was a 70% increase in deal value in 2020 compared to 2019.

With no catalyst in sight to lead Singapore stocks to more reasonable valuations, it is very likely that these low valuations will persist, leaving room for acquirers to swoop in.

Taking advantage?

This could open the door to a potential strategy for investors who want to take advantage of the flurry of privatisation deals. Companies that are most likely to be privatised usually trade at a relatively cheap valuation to earnings or assets and have a large shareholder who can easily consolidate their position.

But that does not mean that investing in potential privatisation targets is a fool-proof strategy.

Predicting which companies could be acquired is a shot in the dark. What may seem like a potential privatisation deal may never materialise, leaving investors holding on to a chronically undervalued stock with no catalyst for rerating the stock.

Although holding on to dividend-paying stocks will provide income while you wait, the limited capital gain could end up hindering investment returns- an expensive price to pay when stock markets in other parts of the world are rising considerably.

Final thoughts

Many investors may consider Singapore a boring stock market with few companies offering attractive business growth, but the low valuations of some companies may throw up unique opportunities for acquirers and investors alike. 

Nevertheless, investors who are looking to speculate on privatisation targets should proceed with caution. If a deal does not materialise as you had hoped for, the stock may trade sideways for years, becoming an expensive opportunity cost in a rising market.

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Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have no vested interest in any companies mentioned. Holdings are subject to change at any time.

Software-as-a-service (SaaS) companies are one of the more exciting groups of growth companies in the market today. Many SaaS companies are growing their businesses at lightning speed, boast giant addressable markets, fat gross margins, and have sticky user bases. 

With the recent drop in SaaS valuations, it may be a good time now to take a look at which SaaS companies are offering the best valuations and growth.

Scatterplot of SAAS companies

In his recent weekly update on SaaS stocks, venture capitalist Jamin Ball provided a scatterplot of US-listed SaaS companies based on their growth and enterprise-value-to-next-12-months (EV-NTM) revenue multiple.

The horizontal axis shows the companies’ NTM consensus growth rate, while the vertical axis shows their EV-NTM revenue multiples.

Companies that are further right on the scatterplot are growing the fastest and the companies that are higher up have the highest valuation multiples.

The companies that are expected to grow the fastest in the next 12 months tend to also sport the highest valuation multiples. This is why we see that companies that are further right on the scatter plot tend to be higher up too.

For example, at the most top right of the chart, we see Snowflake Inc (NYSE: SNOW) which is, by some distance, the company that is expected to grow the fastest among US public-listed SaaS companies. It also has the highest EV-NTM revenue multiple at more than 50.

The cheapest SaaS companies today

As investors, the companies that may be the most attractive are those that are further to the right and to the bottom.

The blue line running across the scatterplot is what is statistically called the fitted regression line. This line shows where the companies tend to place in the scatterplot. Anything under the line can, therefore, be considered cheaper than average and vice versa.

From the chart, there are a few notable companies that are trading below the fitted regression line.

These include companies such as Zoom Video Communications Inc (NASDAQ: ZM), Crowdstrike Holdings Inc (NASDAQ: CRWD), Twilio Inc (NYSE: TWLO) and even Snowflake inc.

Notable companies that are above the line are Bill.com Holdings Inc (NYSE: Bill), Cloudfare Inc (NYSE: NET) and Shopify Inc (NYSE: SHOP).

Other things to consider?

While the scatterplot does give us a good comparison of the growth and valuation of SaaS companies, investors have to consider other factors too.

Some important things to consider include:

• Sustainability of growth: The chart only shows the consensus growth estimate for the next 12 months. Companies that can sustain growth at a high rate for a long time, or accelerate their growth beyond the 12 months consensus, should warrant a higher multiple. Factors that can affect sustainability are balance sheet strength, management capability, size of the addressable market etc.
• Margins: Investors tend to use revenue multiples to value non-profitable SaaS companies. This makes sense due to the absence of profit but as revenue is a high-level metric, it tells us little about the company’s eventual profitability which is what counts in the end. As such, companies that boast higher gross margins and the ability to increase operating leverage warrant being priced at a higher multiple
• Organic vs inorganic growth: Related to the sustainability of growth, the type of revenue growth is also important. If the growth is coming from the consolidation of revenue due to an acquisition, then this revenue growth will be a one-off.

An exciting place to invest…

Thanks to the ease and affordability of SaaS products, they have increasingly become part and parcel of not just everyday business dealings, but everyday life. From customer relations management to human capital resource management to video communication, SaaS has become something we can’t live without.

With the scalability of the cloud and the relatively tiny incremental cost of deploying the product to each new customer, SaaS companies enjoy operating leverage and immense growth potential. Gartner predicts that SaaS revenue will grow from US$104 billion in 2020 to US$140 billion in 2022. 

Investors who are keen to invest in the space should consider valuations, growth, sustainability of the growth, and profit margins.

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Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in the shares of Shopify, Twilio, and Zoom. Holdings are subject to change at any time.

Note: Data as of 8 March 2021; an earlier version of this article was first published in The Business Times on 17 March 2021

Technology stocks in the USA have not been in the good graces of market participants in recent weeks. Take for instance, the NASDAQ index, which has a heavy weighting (nearly half) toward companies in the technology sector. The index closed at a high of 14,095 this year on 12 February 2021, before falling by 10.5% to 12,609 on 8 March.

Many technology companies’ share prices fared far worse over the same period. E-signature specialist DocuSign’s share price declined by 27%. Peloton, which sells its eponymous internet-enabled indoor bikes, saw its share price fall 34%. Latin American e-commerce powerhouse MercadoLibre, digital payments provider PayPal, and e-commerce enabler Shopify, were down by 30%, 24%, and 26%, respectively. Fiverr, which runs an online platform to connect freelancers with businesses looking for freelancing services, experienced a 39% drop in its share price.

What’s behind the declines?

Rising interest rates have often been cited as the key reason for the recent turmoil in technology stocks. The US 10-year Treasury yield, an important interest-rate-marker, had increased from 1.20% on 12 February 2021 to 1.59% on 8 March 2021.

There’s plenty of attention being paid to interest rates because of its theoretical link with stock prices. Stocks and other asset classes (bonds, cash, real estate etc.) are constantly competing for capital. In theory, when interest rates are high, the valuation of stocks should be low, since bonds, being an alternative to stocks, are providing a good return. On the other hand, when interest rates are low, the valuation of stocks should be high, since the alternative – again, bonds – are providing a poor return.

Some stocks in particular, such as high-growth companies that depend on the future growth of their long run cash flows for the lion’s share of their value, are theoretically even more sensitive to changes in interest rates. The technology companies I mentioned earlier that have experienced sharp falls in their share prices belong to this category.

Beneath the hood

But a few things are worth pointing out about the idea of interest rates being a massive driver for the recent volatility seen in technology stocks.

Firstly, the US 10-year Treasury yield was at less than 0.70% at the end of March 2020, which was near the nadir of the pandemic panic that the financial markets experienced last year. So in less than one year, the US 10-year Treasury yield had doubled and then some. The NASDAQ index, meanwhile, gained 64% from the end of March 2020 to 8 March 2021.

Secondly, the real relationship between interest rates and stock market valuations is nowhere near as clean as what’s described in theory. Yale economist Robert Shiller, who won a Nobel Prize in 2013, has a database on interest rates and stock market prices, earnings, and valuations going back to the 1870s. According to his data, the US 10-year Treasury yield was 2.3% at the start of 1950. By September 1981, it had risen to 15.3%, the highest rate recorded in Shiller’s dataset. In that same period, the S&P 500’s price-to-earnings (P/E) ratio moved from 7 to…  8. That’s right, the P/E ratio for the S&P 500, a broad-based US stock market index, increased slightly despite the huge jump in interest rates.

(It’s worth noting too that the S&P 500’s P/E ratio of 7 at the start of 1950 was not a result of earnings that were temporarily inflated.)

Yes, I’m cherry picking with the dates for the second point. For example, if I had chosen January 1946 as the starting point, when the US 10-year Treasury yield was 2.2% and the P/E ratio for the S&P 500 was 19, then the theoretical relationship between interest rates and stock market valuations would appear to hold up nicely.

But what I’m really trying to say with the first and second points are these: Interest rates have a role to play, but it is far from the only thing that matters and; one-factor analysis in finance – “if A happens, then B will occur” – should be largely avoided because clear-cut relationships are rarely seen.

So what’s really going on?

The recent volatility in technology stocks might be due to stocks simply doing what stocks do: Experiencing wild price fluctuations. 

Even the stock market’s greatest long-term winners have also been through periods of sickening declines. We can look at two US-based companies that are well-known to Singaporeans: Amazon.com (NASDAQ: AMZN), the e-commerce and cloud computing juggernaut, and Netflix (NASDAQ: NFLX), the global streaming services provider. In the 10 years ended 8 March 2021, Amazon.com and Netflix’s share prices were both up by 1,670%. By any measure, they have both been massive long-term success stories.

But in that period, both companies saw their share prices decline by 20% or more from a recent high on at least six separate occasions each. So in the past decade, Amazon.com and Netflix – two US-listed stocks with massive long-term gains – have both experienced share price falls of 20% or more every 1.7 years on average.

An important takeaway for investors here is that volatility is a feature of the stock market. It’s something normal. Accepting this can also lead to a healthy change in our mindset toward investing in stocks. Instead of seeing short-term volatility in stocks as a fine, we can start seeing it as a fee – the price of admission, if you will – for great long-term returns. This is an idea that venture capitalist Morgan Housel (who also happens to be one of my favourite finance writers) once described. 

So what should investors focus on now when it comes to technology stocks?

If you’re an investor in US-listed technology stocks, it has been a painful few weeks. In times like these, it’s easy to forget that stocks represent partial ownership of businesses. It’s important to remember what stocks represent, because it will be the performance of a stock’s business that will ultimately determine where its price ends up. Earlier, I said that clear-cut relationships in finance are rarely seen – this is one of those rare times.

We can take some cues from Warren Buffett. The legendary investor gained control of Berkshire Hathaway in May 1965. At the start of that year, the US 10-year Treasury yield was 4.2%, according to Shiller’s data. I mentioned earlier that the highest interest rate seen in Shiller’s dataset for the US 10-year Treasury was 15.3% and that occurred in September 1981. From 1965 to 1981, a 21.4% annual increase in Berkshire’s book value per share drove a 25.1% annual jump in the company’s share price. 21.4% in, 25.1% out, over a 17 year period (1965-1981), despite the massive increase in the yield for US 10-year Treasuries. 

So if you’re interested in technology stocks or are currently invested in them, focus on their business fundamentals while knowing that their share prices are going to be all over the place in the short run. Will their businesses grow materially in the years ahead? And are their current valuations sensible in the context of your estimation of their growth? The answers to these questions will be far more important to technology stocks’ future prices in the long run compared to where interest rates are headed.

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Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I have a vested interest in the shares of Amazon, DocuSign, Fiverr, MercadoLibre, Netflix, PayPal, and Shopify. Holdings are subject to change at any time.

The share prices of SaaS (software-as-a-service) companies have risen massively over the past year. Even after the sharp pullback many of them experienced in late-February and March this year, the share prices of SaaS companies still trade at relatively higher multiples than they did in the recent past.

The chart below by venture capitalist Jamin Ball shows current SaaS company valuations:

The blue line on the chart shows that the median EV-to-NTM revenue (median enterprise value to next twelve months revenue) multiple for SaaS companies has risen sharply in the last two years. And despite the sell-off over the last couple of weeks, SaaS companies still trade at a higher multiple than they did at any other time before mid-2020. 

This has led to some investors assuming that SaaS company valuations are still too high.

On the surface, that may seem the case but it could also be that valuations for SaaS companies were simply way too low in the past.

Justified?

Venture capital firm Bessemer Venture Partners (BVP) has an index of emerging cloud-computing companies – many of which are SaaS companies – that are listed in the US stock market. The chart below shows the performance of the BVP cloud index (EM Cloud) relative to other major US stock market indexes.

The blue line shows the BVP cloud index. Since tracking began, the BVP cloud index has significantly outperformed the rest of the market. It has even outperformed the tech-heavy NASDAQ by 3.6 times. 

Part of the cloud index’s growth was undoubtedly fueled by an expansion in the aforementioned EV-to-NTM revenue multiples that SaaS companies have experienced. But a big part of the growth is also due to the relatively faster revenue growth in SaaS companies.

Doing some quick math and assuming that revenue multiples contract from 14 to 5 times (what they were in 2015), the BVP cloud index would still be outperforming the NASDAQ – the BVP cloud index outperformed the NASDAQ by 3.6 times while the multiple expansion in SaaS companies included in Jamin Ball’s graph was just 2.8 times*. 

Given all of this, rather than assuming that current valuations of SaaS are too high, it could be that historical valuations were actually too low.

Market participants in the past may have underestimated SaaS companies’ growth potential and the sustainability of that growth.

Today, the market may have wisened up to the immense addressable market opportunity of cloud companies and are beginning to better price in their immense potential.

Conclusion

SaaS companies are currently still trading at higher EV-NTM revenue multiples than they were in the past. Just taking this fact alone, one may assume that valuations are stretched now.

But if we take a step back, we can see that SaaS companies may have been mispriced in the past. The pace and sustainability of revenue growth should have warranted a higher valuation back then.

The market may now be smartening up to the wonderful economics that SaaS companies offer. Not only do best-in-class SaaS companies offer a long growth runway, but they also address a huge and growing market.

If their revenues continue to grow as fast it has in the past, SaaS stocks will likely keep going higher.

*Jamin Ball’s universe of SAAS companies and those in the BVP cloud index may not be exactly the same but there is a significant overlap

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Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

This week, The Information reported that Chinese tech conglomerate, Tencent Holdings Ltd (HKG: 0700), has made a killing from its investment portfolio.

In 2020 alone, the tech giant made US$120 billion in unrealised gains from its minority stakes in about 100 publicly listed companies. That’s around six times as much as Tencent’s own projected operating profit for the whole of 2020.

Tencent, which began life as a messaging company, has grown to become a diversified tech behemoth, with operations spanning cloud computing, social networks, enterprise software, mobile payments, and much more. 

But outside of its operational businesses is where all the fun truly begins. China’s largest tech company has minority stakes in companies ranging from electric vehicle manufacturers to e-commerce, music streaming to ride-hailing and payments and much more. 

Without exaggeration, Tencent’s investments in publicly-listed companies look like a who’s who of tech companies. Tencent owns stakes in Meituan (HKG: 3690), Sea Ltd (NYSE: SE), JD.com Inc (HKG: 9618), Pinduoduo Inc (NASDAQ: PDD), Tesla Inc (NASDAQ: TSLA), Spotify (NYSE: SPOT), Nio Inc (NYSE: NIO), Afterpay Ltd (ASX: APT), Snapchat (NYSE: SNAP), and many more.

But that’s just the tip of the iceberg.

Tencent also owns significant stakes in up and coming privately-held companies such as Gojek, Ola, Reddit, Epic Games, Webank ,and many others.

Should other tech giants follow in Tencent’s footsteps?

The apparent success of Tencent’s investment arm has led to the question: Should other big tech companies follow in Tencent’s footsteps?

US-based tech giants such as Alphabet Inc (NASDAQ: GOOGL), Facebook Inc (NASDAQ: FB), Apple Inc (NASDAQ: AAPL), and Microsoft Corporation (NASDAQ: MSFT) boast tens – sometimes hundreds – of billions of dollars on their balance sheets and generate billions more in cash each year.

With so much cash lying around, their shareholders may be asking if these tech giants are doing enough with their heaps of cash.

Tencent’s strategy to put its excess cash to use through investments in public equities and young startups are starting to pay off and seems to be the perfect blueprint for other cash-rich companies to follow.

Why minority investments may make sense

Tech giants are usually not known to make minority investments in companies but rather prefer buying up whole companies to reap the benefits of synergies.

But, arguably, minority investments may actually be an even more cost-efficient way to put their capital to use. Acquiring whole companies is a more tedious process, which regulators scrutinise. In addition, the acquirer tends to have to pay a big premium to purchase a company outright.

On the other hand, minority investments can be made much less publicly and usually at relatively better valuations.

Taking minority stakes also offers the US tech giants the ability to dip their toes in a range of different companies that would not be possible if they wanted to make whole acquisitions. Moreover, the US tech giants also have a significant advantage as they can provide portfolio companies with expertise, networks, and partnerships.

It therefore would not be surprising to find that young companies may want to have these tech giants as investors to leverage their technology and expertise. This could open the door for the US tech giants to get in on some of the most sought after companies in the world.

Maybe the US tech giant that is most akin to Tencent is Alphabet. The parent company of Google has two investment arms, one of which is called GV, formerly known as Google Ventures. GV’s current assets under management is only around US$5 billion, less than 5% the size of Tencent’s portfolio but it is a good start. GV has investments in companies such as Medium, Uber, Stripe, Impossible Foods and many more. 

Expertise required…

Despite the apparent upside, making minority investments in companies is by no means an easy task.

Investing in early-stage companies, or even publicly-listed entities, requires patience and expertise. Tencent, though, seems to have found a winning formula with many of its investments working out extremely well so far. But other big tech companies, with their access to talent, should be able to replicate Tencent’s success should they choose to follow a similar path.

They will need time and money to bring the best talent to manage their vast amounts of capital but, if successful, the fruits of these investments could be substantial.

The bottom line

Tencent is a great example of how companies that generate billions of dollars in cash every year can put their excess capital to use. Tencent has created a tech behemoth that spans numerous businesses and has diversified its investment portfolio to an extent that is unmatched by any company in the world.

Other tech giants could potentially follow suit.

Rather than letting their cash build up, or simply returning cash to shareholders through buybacks or dividends, investing the capital through minority-stake investments could be an even better use of cash.

While the market’s bull run in tech companies in 2020 may never be replicated, there is still value being created by tech companies around the globe today. With billions of dollars in their banks, the Apples and Facebooks of this world can certainly look to capitalise on that.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in the shares of Afterpay, Alphabet, Apple, Facebook, Meituan, Microsoft, Tencent, and Tesla. Holdings are subject to change at any time.

A company’s earnings conference call can be extremely informative. Not only does it provide information on how a company has done in the last quarter, but management also gives investors a glimpse into the early trends shaping the company’s future.

With many companies having reported their full-year earnings results for 2020, here are some of the key management insights on what to expect in the year ahead. 

Video conferencing is here to stay…

Leading video conferencing company, Zoom Video Communications Inc (NASDAQ: ZM) capped off a truly remarkable year as it reported a 369% year-over-year increase in revenue for the fourth quarter of its fiscal year ended 31 January 2021 (FY2021).

On a full-year basis, Zoom saw revenue increase by 326%. More impressively, the company expects to build on that solid performance as management forecasts a further 42% increase in revenue for FY2022.

Zoom’s founder-CEO, Eric Yuan, said:

“As the world emerges from the pandemic, our work has only begun. The future is here with the rise of remote and work-from-anywhere trends.”

With employers getting used to remote working conditions, many are starting to embrace the convenience, efficiencies, and cost-savings associated with it. In addition, employees prefer the flexibility of working remotely.

We have already seen companies such as Shopify (NYSE: SHOP) announcing a permanent shift toward remote working. As forward-looking employers pave the way, the shift towards permanent remote work is only just beginning.

E-commerce growth to normalise but upward trend to persist

There was an interesting chart put up by Shawspring Partners earlier this year showing the e-commerce penetration growth that took place in early 2020 as countries around the world began lockdowns to combat COVID-19.

As the chart shows, e-commerce penetration in the USA grew as much as it did in the eight weeks leading up to April 2020 as it did in the 10 years before then.

Consequently, the leading e-commerce marketplace for entrepreneurs and DIYers, Etsy (NASDAQ: ETSY) saw a 107% increase in annual gross merchandise sold on its platform in 2020. Meanwhile, e-commerce enabler Shopify experienced 96% year-on-year growth in the gross merchandise volume (GMV) facilitated by its platform during the year.

Although e-commerce growth rates are expected to normalise, the overall upward trend should persist.

Shopify CFO, Amy Shapero, said in the company’s 2020 fourth-quarter earnings conference call:

“Our outlook coming into 2021 assumes that as countries roll out vaccines in 2021 and populations are able to move about more freely, the overall economic environment will likely improve, some consumer spending will likely rotate back to offline retail and services and the ongoing shift to e-commerce, which accelerated in 2020, will likely resume a more normalized pace of growth.”

Similar to how remote work is advantageous over traditional office set-ups, e-commerce holds many advantages over traditional retail. 

Online purchasing is more convenient, offers shoppers a wider selection of products, and tends to be cheaper. It is inevitable that these advantages will result in an eventual migration of more purchases from offline to online over the longer term. 

The rise of BNPL (buy now, pay later)

Consumers are increasingly looking for smarter ways to pay for their purchases.

Enter buy now, pay later services. As the name suggests, buy now, pay later – or BNPL – allows customers to buy a product or service and pay for it in instalments, often interest-free, over a few weeks after the purchase is made.

Millennials increasingly prefer this option as it provides greater cash flow flexibility. And unlike credit cards, BNPL does not result in expensive interest expenses snowballing should they miss any payments.

This year, Shopify teamed up with Affirm (NASDAQ: AFRM) to offer its merchants the ability to accept BNPL functions from customers.

Meanwhile, digital payments giant, Paypal (NASDAQ: PYPL), has also gotten in on the act, as it launched its BNPL service late in 2020. The take up was so good that Paypal CEO Dan Schulman said in the 2020 fourth-quarter earnings conference call:

“I would also highlight the rapid growth of our buy now, pay later functionality. We saw tremendous and growing demand throughout the quarter and witnessed the fastest start to any product we have ever launched.”

Afterpay (ASX: APT), a leading BNPL provider, also reported a staggering 106% increase in underlying sales in the six months ended 31 December 2020.

With the rise of e-commerce and millennials increasingly looking for better ways to manage their cash flow and expenses, it seems that BNPL companies are set for a bright future.

Final thoughts

Covid-19 accelerated the digitalisation of the world.

Although economies will eventually reopen, the way we live, work and play will have changed. As the world adapts, companies that embrace these changes stand to gain the most.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in the shares of Afterpay, PayPal, Shopify, and Zoom. Holdings are subject to change at any time.

The company with the deepest pockets often wins.

Having more money than your competitors can further your technology advantage, allow you to market more aggressively to get a stronger network effect, or simply to scale up production more quickly.

This is why founders can be found scrambling around Silicon Valley trying to raise capital. But raising capital is not reserved solely for privately held startups. 

In fact, many fast-growing public companies are increasingly looking for ways to raise capital cheaply, be it through debt or secondary equity offerings.

Raising capital through secondary equity offerings

One of the more common ways to raise money in today’s market is through a secondary offering. A secondary offering is simply the sale of new shares to investors by an already public-listed company. This is especially appealing for a company when its stock price has increased to a lofty valuation, a likely phenomenon for tech stocks in today’s market.

We need to look no further than one of 2020’s hottest stocks, Tesla Inc (NASDAQ: TSLA). The electric vehicle company took advantage of its rising stock price to raise money no less than three times last year. Tesla first raised US$2 billion in February at a split-adjusted share price of around US$153. It quickly followed that up in September and December, raising another US$5 billion each time as its share price soared.

Despite raising around US$12 billion in capital through secondary offerings in 2020, Tesla’s effective dilution to shareholders was likely less than 5% from all the offerings combined. This is a huge advantage that Tesla has over its competitors. 

The leading electric vehicle company now has deeper pockets, giving it the ability to scale production faster and to invest more to improve its battery and software technology. 

Tesla is not the only company that has taken advantage of soaring stock prices. Singapore’s e-commerce and gaming company, SEA Ltd (NYSE: SE), and communications API leader, Twilio Inc (NYSE: TWLO), are just two other examples of prominent large companies that have pounced on their soaring share prices to raise relatively inexpensive capital through secondary share offerings.

Debt markets

Another way to raise money is through the debt markets. Rather than diluting shareholders, bond offerings and bank loans are another way to raise capital. 

Even though companies incur interest expenses and will eventually need to pay back their creditors, debt does not dilute shareholders. In addition, the current low-interest-rate environment enables companies to issue bonds or take up loans at very competitive rates.

Netflix Inc (NASDAQ: NFLX) is an example of a company using the debt market effectively. In the past few years, Netflix’s operating cash flow was negative, as it was spending heavily on content creation. As such, the company needed more capital. Netflix CEO Reed Hastings and his team decided that rather than dilute shareholders through equity offerings, it would issue high yield bonds to pay for its expenses. The result was that the company managed to get the required capital, whilst not diluting existing shareholders. 

Although Netflix’s balance sheet may look weak because of the debt, the streaming giant has a clear path to free cash flow generation and should be able to start paying off some of its debt this year.

Over the longer term, Netflix shareholders could start reaping the returns of management’s careful planning and the fact that they were not diluted from Netflix’s debt offerings.

A mix of both?

So far I have discussed companies that have raised capital through secondary share offerings and debt. Another way for companies to raise capital is through an instrument that could be considered a mix of both – and it may be the best way to raise capital.

Convertible bonds are bonds that can be converted to shares at a certain date or when a certain event occurs. These bonds tend to have very low coupon rates and if converted, are usually done so at a large premium to current share prices.

For instance, leading website creation company, Wix.com Ltd (NASDAQ: WIX) raised US$500 million in August 2020 by issuing convertible bonds that are due in 2025.

Get this. The bonds have a 0% coupon, meaning that Wix does not pay any interest to bondholders. On top of that, these bonds convert to Wix shares at a whopping 45% premium to Wix’s last reported share price prior to the announcement of the sale of the bonds.

As such, if the bonds do get converted to shares, the amount of dilution is lower than if the company simply offered a secondary offering which is usually priced at a discount to current share prices.

Why then would anyone want to buy such an instrument? Personally, I much rather buy equity directly than to own convertible bonds. Nevertheless, convertible bonds do serve a purpose for more risk-averse investors.

First of all, bondholders will get their principle back even if the company’s shares fall below the conversion price. They also have a more senior right to the company’s assets should the company run into financial trouble – this provides additional downside security for investors. The convertible aspect of the bonds also offers bondholders “equity-like” upside if Wix’s share price rises beyond the conversion price. However, bondholders are paying a huge premium for the hedge, which I personally would not want to do for my portfolio.

Closing words

The ability to raise capital cheaply is a competitive advantage for a company that is often overlooked by investors.

Having deep pockets could give companies a leg up against their competition in a time when scale and technology are increasingly important.

Shareholders may sometimes frown on companies that are issuing new shares or taking on more debt. But if the company uses its newfound financial muscle to good effect, the new capital could be the difference between emerging a winner or ending up as an obsolete wannabe.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in the shares of Tesla, Twilio, Netflix, and Wix.com. Holdings are subject to change at any time.

Technology is changing the world, fast. The COVID-19 pandemic has accelerated software and other technology adoption around the globe. And this is likely just the beginning of a multi-year trend. With this in mind, here are some tech trends that I am keeping an eye on.

Programmatic advertising

Programmatic advertising is a way to automatically buy digital advertising campaigns across a wide spectrum of publishers rather than from an individual publisher. Instead of going to a specific vendor to reserve a digital space on their website, advertising real estate is aggregated in ad exchanges where they can be bought or sold. Programmatic advertising software, in turn, communicates with these ad exchanges to buy and sell these advertising spaces, streamlining and optimising the advertising campaigns for advertisers.

In 2021, a whopping 88% of all digital display advertising in the USA is projected to be transacted via programmatic advertising.

According to Research And Markets, the global market for programmatic advertising platforms is estimated at US$5.2 billion in 2020 and is expected to reach US$33.7 billion in 2027, a nearly 31% compounded annual growth rate.

Alphabet (NASDAQ: GOOGL)(NASDAQ: GOOG), the parent company of Google, is likely going to be a key beneficiary of this as they dominate the programmatic advertising space with their Adwords platform. Amazon Inc’s (NASDAQ: AMZN) demand-side platform for advertisers has also gained market share in recent years. But we shouldn’t write off independent specialised programmatic advertising companies such as The Trade Desk (NASDAQ: TTD).

A key advantage that an independent programmatic advertising platform such as Trade Desk has over Google Adwords is that it is truly independent, so it will help ad buyers purchase the best digital ad-spaces the platform can find for the buyers’ needs. Google Adwords, on the other hand, may have a preference for Google properties, which may not be the best properties for ad buyers on certain occasions.

Whatever the case, with programmatic advertising exploding in popularity, there will likely be room for multiple winners in this space.

Solar energy

Under the Paris Agreement, participant countries have set a goal to limit global warming to an increase of preferably less than 1.5 degrees celsius compared to pre-industrial levels. This can only be achieved if more of the electricity the world produces comes from clean sources.

One of the most reliable sources of clean energy will be the sun. Solar power is 100% clean, renewable, and reliable. As such, governments around the world are creating policies to incentivise greater use of solar energy for homes and for commercial purposes.

Just as importantly for uptake, the cost of solar energy is coming down. According to the International Renewable Energy Agency, since 2010, the cost of energy production has dropped by 82% for photovoltaic solar and 47% for concentrated solar energy.

Global solar production capacity has also risen from 40GW in 2010 to 580 GW in 2019, suggesting the global demand for solar energy is taking effect. China continues to lead this space, accounting for 35.4% of the global market in 2018. This is driven by huge government initiatives in China in a bid to accelerate clean energy adoption.

In the USA, with the environment-conscious Democratic party taking the majority of the Senate, political observers expect greater impetus for the US government to support solar power.

Companies such as First Solar (NASDQ: FSLR), SolarEdge (NASDAQ: SEDG), JinkoSolar (NYSE: JKS), Enphase Energy (NASDAQ: ENPH), and ReneSola (NYSE: SOL) could stand to benefit.

Electric vehicles

In a similar vein to solar energy, electric vehicles are a cleaner alternative to ICE (internal combustion engine) vehicles. In the past, electric vehicles were slow to gain adoption due to the high cost of batteries and slow charging times. There were also the concerns of short range (distance that can be driven before the vehicle requires charging again) and poor charging infrastructure for electric vehicles due to a lack of charging stations.

But all of this has changed.

The infrastructure in many countries have slowly taken shape while the specifications of electric vehicles are improving at a tremendous pace. Most prominently, charging times, range, and cost have all improved, leading to greater demand from environmentally conscious consumers.

In addition, governments have stepped in to implement policies to encourage the sales of electric vehicles. California has gone as far as to ban the sale of new gasoline-powered vehicles by 2035.

Global passenger electric vehicle sales jumped from 450,000 in 2015 to 2.1 million in 2019. But there is still huge room for growth. In 2020, only 2.7% of total vehicle sales were electric. That figure is expected to rise to 10% by 2025. In the next decade, more than 100 million electric vehicles are expected to be sold around the world.

Tesla (NASDAQ: TSLA) is the largest electric vehicle player in the market, delivering close to 500,000 vehicles in 2020. But this is just the beginning. Tesla is ramping up production quickly, breaking ground on new factories in Berlin and Texas. It is also expected to start production of vehicles in its New York factory which used to be solely for solar panels.

On top of that, its Shanghai and Fremont factories are both not producing at full capacity yet. The two existing factories can increase their annual output in the next few years. Some are projecting Tesla to deliver between 840,000 to 1 million cars in 2021.

With no shortage of demand and no need for advertising (due to incredible consumer mind share), ramping up production will lead to more car sales and more revenue and gross profits for Tesla.

Tesla has also recently taken advantage of its soaring share price to raise new capital. It raised at least US$10 billion in the second half of 2020 through issuing new shares, and these moves provides the company with ammunition to accelerate its production capacity further.

But Tesla is not the only electric vehicle company in town. In the USA, legacy automobile manufactures such General Motors Company (NYSE: GM) and Ford Motor Company (NYSE: F) have been investing in their own electric vehicle models.

Global giants, Toyota (TYO: 7203) and Volkswagen (ETR: VOW3), have also signalled their intent to pivot their business. Other pure play electric vehicle startups in China such as Nio (NYSE: NIO), Li Auto (NASDAQ: LI), and  Xpeng (NYSE: XPEV) are also jostling for a piece of the pie. Analysts estimate that there will be 500 different models of electric vehicles globally by 2022.

Whatever the case, multiple winners are set to emerge from this fast-growing space.

Conscious eating

Sticking to the same theme of environmentally conscious consumers, fake meat is becoming the next big trend in conscious eating.

Fake meat refers to either plant-based protein, or lab-grown cell-based protein. In the plant-based space, proteins are extracted and isolated from a plant and then combined with plant-based ingredients to make the product taste and look like meat. Examples of plant-based proteins are Beyond Meat (NASDAQ: BYND) and Impossible Meat.

In lab-grown cell-based meat, an animal cell is extracted from an animal and grown in lab culture. This technology is still not yet in mass production as far as I know, but Singapore was the first to approve lab-grown meat for commercial sales.

Although fake meat is clearly better for the environment, consumer take up has not been rapid due to the high cost of production. Like electric vehicles, in order for fake meat to truly become mainstream, it needs to reach or exceed cost parity with traditional meat – and it needs to taste good.

Temasek-backed Impossible Foods is on the path to reduce cost to consumers. Earlier this year, Impossible Foods announced that it will be lowering prices by around 15% for its open-coded food service products, its second price cut since March 2020.

Another key driver of growth is the sale of fake meat in restaurant chains. McDonald‘s (NYSE: MCD) has decided to debut its own plant-based meat alternative called McPlant in 2021, which Beyond Meat helped to co-create.

According to the research firm, Markets and Markets, the plant-based meat market is estimated to be US$4.3 billion in 2020 and is projected to grow by 14% per year to US$8.3 billion by 2025.

Final words

We are indeed living in exciting times. The world is so dynamic and with new technologies and trends emerging, companies at the forefront of these shifts in demand are primed to reap the rewards.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in the shares of Amazon, Alphabet, The Trade Desk and Tesla. Holdings are subject to change at any time. Holdings are subject to change at any time.

In December 2019, I published 6 Things I’m Certain Will Happen In The Financial Markets in 2020. The content of the article is a little cheeky, because it describes incredibly obvious things, such as “interest rates will move in one of three ways: sideways, up, or down.”

But I wrote the article in the way I did for a good reason. A lot of seemingly important things in finance, things with outcomes that financial market participants obsess over and try to predict, actually turn out to be mostly inconsequential for long-term investors. I thought the article is important to help investors develop perspective on what’s going on in the markets, so I shall write one again for 2021! If you’ve read the 2020 version, you’ll find a lot of the content to be similar – but you can treat it as a refresher anyway! If this is new to you, then let me introduce you to my absolutely broken but still useful crystal ball…

Here are six things I’m certain will happen in 2021:

1. There will be something huge to worry about in the financial markets.

Peter Lynch is the legendary manager of the Fidelity Magellan Fund who earned a 29% annual return during his 13-year tenure from 1977 to 1990. He once said:

“There is always something to worry about. Avoid weekend thinking and ignore the latest dire predictions of the newscasters. Sell a stock because the company’s fundamentals deteriorate, not because the sky is falling.”

Imagine a year in which all the following happened: (1) The US enters a recession; (2) the US goes to war in the Middle East; and (3) the price of oil doubles in three months. Scary? Well, there’s no need to imagine: They all happened in 1990. And what about the S&P 500? It has increased by nearly 950% from the start of 1990 to today, even without counting dividends. 

And as a reminder, 2020 has been a year of upheavals in the global economy. Nearly the entire world is currently struggling with COVID-19 and the pandemic has caused significant contractions in economic activity in many countries, with unemployment also being a serious problem. The USA is one of the worst-hit countries, yet the US stock market has risen. From the start of 1990 to December 2019, the S&P 500 was up by around 800% without counting dividends. The gain from the start of 1990 to December 2020, as I showed just above, has increased to 950% – in the midst of an unprecedented pandemic. 

There will always be things to worry about. But that doesn’t mean we shouldn’t invest.

2. Individual stocks will be volatile.

From 1997 to 2018, the maximum peak-to-trough decline in each year for Amazon.com’s stock price ranged from 12.6% to 83.0%. In other words, Amazon’s stock price had suffered a double-digit fall every single year. Meanwhile, the same Amazon stock price had climbed by 76,000% (from US$1.96 to more than US$1,500) over the same period.

If you’re investing in individual stocks, be prepared for a wild ride. Volatility is a feature of the stock market – it’s not a sign that things are broken. 

3. The US-China trade war will either remain status quo, intensify, or blow over.

“Seriously!?” I can hear your thoughts. But I’m stating the obvious for a good reason: We should not let our views on geopolitical events dictate our investment actions. Don’t just take my words for it. Warren Buffett himself said so. In his 1994 Berkshire Hathaway shareholders’ letter, Buffett wrote (emphases are mine):

“We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen. 

Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%.

But, surprise – none of these blockbuster events made the slightest dent in Ben Graham’s investment principles. Nor did they render unsound the negotiated purchases of fine businesses at sensible prices. 

Imagine the cost to us, then, if we had let a fear of unknowns cause us to defer or alter the deployment of capital. Indeed, we have usually made our best purchases when apprehensions about some macro event were at a peak. Fear is the foe of the faddist, but the friend of the fundamentalist.

A different set of major shocks is sure to occur in the next 30 years. We will neither try to predict these nor to profit from them. If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results.”

From 1994 to 2019, Berkshire Hathaway’s book value per share, a proxy for the company’s value, grew by 13.9% annually. Buffett’s disciplined focus on long-term business fundamentals – while ignoring the distractions of political and economic forecasts – has worked out just fine.

4. Interest rates will move in one of three ways: Sideways, up, or down.

“Again, Captain Obvious!?” Please bear with me. There is a good reason why I’m stating the obvious again.

Much ado has been made about what central banks have been doing, and would do, with their respective economies’ benchmark interest rates. This is because of the theoretical link between interest rates and stock prices.

Stocks and other asset classes (bonds, cash, real estate etc.) are constantly competing for capital. In theory, when interest rates are high, the valuation of stocks should be low, since the alternative to stocks – bonds – are providing a good return. On the other hand, when interest rates are low, the valuation of stocks should be high, since the alternative – again, bonds – are providing a poor return. 

But if we’re long-term investors in the stock market, I think we really do not need to pay much attention to what central banks are doing with interest rates.  

There’s an amazing free repository of long-term US financial market data that is maintained by economics professor and Nobel Prize winner Robert Shiller.

His data contains long-term interest rates in the US as well as US stock market valuations going back to the 1870s. The S&P 500 index is used as the representation for US stocks while the cyclically adjusted price earnings (CAPE) ratio is the valuation measure. The CAPE ratio divides a stock’s price by its inflation-adjusted average earnings over a 10-year period.

The chart below shows US long-term interest rates and the CAPE ratio of the S&P 500 since the 1880s:

Contrary to theory, there was a 30-plus year period that started in the early 1930s when interest rates and the S&P 500’s CAPE ratio both grew. It was only in the early 1980s when falling interest rates were met with rising valuations. 

To me, Shiller’s data shows how changes in interest rates alone can’t tell us much about the movement of stocks. In fact, relationships in finance are seldom clear-cut. “If A happens, then B will occur” is rarely seen.

Time that’s spent watching central banks’ decisions regarding interest rates will be better spent studying business fundamentals. The quality of a company’s business and the growth opportunities it has matter far more to its stock price over the long run than interest rates. 

Sears is a case in point. In the 1980s, the US-based company was the dominant retailer in the country. Morgan Housel wrote in his recent blog post, Common Plots of Economic History :

“Sears was the largest retailer in the world, housed in the tallest building in the world, employing one of the largest workforces.

“No one has to tell you you’ve come to the right place. The look of merchandising authority is complete and unmistakable,” The New York Times wrote of Sears in 1983.

Sears was so good at retailing that in the 1970s and ‘80s it ventured into other areas, like finance. It owned Allstate Insurance, Discover credit card, the Dean Witter brokerage for your stocks and Coldwell Banker brokerage for your house.”

US long-term interest rates fell dramatically from around 15% in the early-to-mid 1980s to around 3% in 2018. But Sears filed for bankruptcy in October 2018, leaving its shareholders with an empty bag. In his blog post mentioned earlier, Housel also wrote:

“Growing income inequality pushed consumers to either bargain or luxury goods, leaving Sears in the shrinking middle. Competition from Wal-Mart and Target – younger and hungrier – took off.

By the late 2000s Sears was a shell of its former self. “YES, WE ARE OPEN” a sign outside my local Sears read – a reminder to customers who had all but written it off.” 

If you’re investing for the long run, there are far more important things to watch than interest rates.

5. There will be investors who are itching to make wholesale changes to their investment portfolios for 2021.

Ofer Azar is a behavioural economist. He once studied more than 300 penalty kicks in professional football (or soccer) games. The goalkeepers who jumped left made a save 14.2% of the time while those who jumped right had a 12.6% success rate. Those who stayed in the centre of the goal saved a penalty 33.3% of the time.

Interestingly, only 6% of the keepers whom Azar studied chose to stay put in the centre. Azar concluded that the keepers’ moves highlight the action bias in us, where we think doing something is better than doing nothing. 

The bias can manifest in investing too, where we develop the urge to do something to our portfolios, especially during periods of volatility. We should guard against the action bias. This is because doing nothing to our portfolios is often better than doing something. I have two great examples. 

First is a paper published by finance professors Brad Barber and Terry Odean in 2000. They analysed the trading records of more than 66,000 US households over a five-year period from 1991 to 1996. They found out that the most frequent traders generated the lowest returns – and the difference is stark. The average household earned 16.4% per year for the timeframe under study but the active traders only made 11.4% per year.

Second, finance professor Jeremy Siegel discovered something fascinating in the mid-2000s. In an interview with Wharton, Siegel said:

“If you bought the original S&P 500 stocks, and held them until today—simple buy and hold, reinvesting dividends—you outpaced the S&P 500 index itself, which adds about 20 new stocks every year and has added almost 1,000 new stocks since its inception in 1957.”

Doing nothing beats doing something. The caveat here is that we must be adequately diversified, and we must not be holding a portfolio that is full of poor quality companies. Such a portfolio burns our wealth the longer we stay invested, because value is being actively destroyed.

6. There are 7.8 billion individuals in the world today, and the vast majority of us will wake up every morning wanting to improve the world and our own lot in life.

This is ultimately what fuels the global economy and financial markets. Miscreants and Mother Nature will wreak havoc from time to time. But I have faith in the collective positivity of humanity. When things are in a mess, humanity can clean it up. This has been the story of mankind’s and civilisation’s long histories. And I won’t bet against it. 

Mother Nature threw us a huge problem this year with COVID-19. Even though vaccines against the virus have been successfully developed, it is still a major global health threat. But we – mankind – managed to build a vaccine against COVID-19 in record time. Moderna, one of the frontrunners in the vaccine race, even managed to design its vaccine for COVID-19 in just two days. This is a great example of the ingenuity of humanity at work.

To me, investing in stocks is the same as having the long-term view that we humans are always striving, collectively, to improve the world. What about you?

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in the shares of Amazon. Holdings are subject to change at any time.