January 21st, 2022
“OMG! THE MAKETS ARE TANKING – WHAT DO WE DO!?”
In recent weeks, I’ve observed waves of emotional, bearish sentiment flooding through Fintwit. Rather than panicking or spreading fear, I believe it is important to examine the data and provide perspective on the matter, before some self-proclaimed “Growth Investor” causes you – dear reader – to make irrational moves.
First of all, I respect anyone who has been in this game for more than ten years. I began my investment banking career in 2008, and started my own personal investment journey around the same time. I won’t lie: the market has given me many difficult and costly lessons in that time – but that’s also the way of this industry, and how you learn. Over the past two years, I’ve also watched as many traders and investors have grown complacent – one might say spoiled, even.
In this market, we’ve seen companies grow at ~20% of their revenue in a year, while their stock prices moved up over 150% in that same timeframe. You can argue that’s because the DCF (discounted cash flow) models we use today are able to accurately predict what happens, more so than in the past – but that’s not the case.
We use the same data and methods of reaching our assumptions as we did before, and we input the same sensitivities into our models. Where I believe the markets collectively went wrong is in the CMA (comparable market analysis). Valuations in tech over the past ten years have – with almost unanimous consent – exploded to levels that would have been scoffed at in the past.
It’s a routine practice in this industry to make a case as to why a certain stock is trading higher than its competitors (and why that stock is still worth buying at those levels) – and it’s not difficult to believe a well-presented case. However, in the rapidly shifting market landscape that followed the crash of 2020, analysts from the largest global investment banks bent over backward to justify stocks trading at progressively higher valuations – to the point where companies wouldn’t meet their forward P/E (price-to-earning) ratios for decades. Some (in not-so-hushed whispers) even began to speculate about the dreaded “B” word (hint: it rhymes with trouble).
One reason for these widely accepted absurd valuations can, I believe, be traced back to the hiring process at major investment banks (such as Morgan Stanley, J.P. Morgan, or Goldman Sachs). When a new analyst is onboarded at one of these locations, they go through a rigorous training session. Often, it’s the same company training the same top analysts at different top banks. In effect, it’s a combination between an echo chamber and the classic “telephone game.”
This distortion in the market analysis landscape has reached a point where we’ve seen VCs (venture capital firms) pitch pre-revenue to <$10M ARR (annual recurring revenue) companies with a >-$100M FCF SPACs (free cash flow special-purpose acquisition companies), based entirely on future growth of business models that haven’t yet proven they have a sustainable business model. It’s easier to get from $10M ARR to $250M provided that they are funded by PE/EQ markets.
It’s a whole different ball game when you try to cross over $250M to $1B in revenue and positive OCF (operating cash flow). This is where those companies fail. Now, their business is impacting the larger players in the game – and those larger businesses have been in the game much longer, with a product offering that is far more vertically integrated. This is where we start to see customers and/or businesses jump ship and switch to these larger competitors.
Take $MSFT (Microsoft) vs. $ZM (Zoom), for example. We all know that $ZM’s growth was largely attributed to the pandemic, with a fair product pricing point (and don’t get me wrong – I think $ZM is at a great valuation right now).
However, just like $ZM has grown, so have their SMB (small and midsize business) clients. As those clients scale up, they will need to have an integrated business solution like $MSFT – which offers business tools like Office 365 in their business premium package at a substantial 35% discount (minus VoIP/Voice over Internet Protocol).
To make matters worse, in the wake of the COVID-19 pandemic, we’ve seen:
– The largest generational wealth shift from Baby Boomers to Gen Xers/Millennials
– An influx of traders with no fundamental or technical knowledge entering the markets en masse
– Several rounds of stimulus checks during the pandemic that many new traders were willing to risk, instead of saving
Combined with the United States Federal Reserve’s unprecedented response of unlimited QE (quantitative easing) to the COVID-19 pandemic, we have seen truly unique market conditions develop over the past two years. One highly visible effect has been the birth of the self-proclaimed “Growth Investor.” Buoyed by 100 bagger gains (and losses) posted daily on Wall Street Bets, millions of freshly minted retail traders entered the game with stars in their eyes, Robinhood in their hands, and not even a basic understanding of market fundamentals or macrotrends.
As the markets melted up practically uninterrupted for nearly two years, the average “Growth Investor” embraced a shared meme mentality: “stonks only go up.” In this time, egos and accounts blew up in both directions, and countless furus were crowned on Fintwit as they hocked paid trade alert subscriptions. Remember: everyone’s a genius in a bull market.
In recent months, however, those same furus are struggling to give their paid members a decent trade, because the cash cow has seemingly run dry and stopped printing (when really that’s not the case – the macros are just shifting). These are the same Fintwit trolls who are fearmongering about another stock market crash, when we’re only 13% down from a 146% two-year melt up. I’m willing to bet that the bulk of that fear is coming from “Growth Investors” who didn’t remain long for even half of that 146%.
My closing remarks to the fearmongering Fintwitters (and to you, dear reader) are simple:
1: It’s not the market’s fault that you chose to hold penny stocks or SPACs instead of quality names (or, if you traded quality names, that you didn’t hold them for more than 15% of their initial parabolic move).
2: It’s not the Fed’s job to bail out the markets – it’s the Fed’s job to bail out the economy. Yes, the market and the economy are disconnected (to a degree); recall the market’s endless melt-up during 2020 at the height of COVID-19, as the bulk of economic action had stalled. The Market != The Economy.
3: Don’t expect another injection of $12T to save you from your bagholds on unprofitable companies (I’m looking at you, $WISH holders.)
4: Inflation is horrible, yes, but we’ve known this was coming (with 7% projections) since March of last year. I expect inflation to decline in the second half of 2022.
5: Keep an eye on freight costs – we’re not out of the supply chain water-woods just yet.
6: Many growth names are trading at 2017/2018 multiples now, so if there was ever a time again to take fresh entries for killer swing trade callouts (to show off to your Fintwit followings), well – that time may be soon…
My final point is this: in the newly emerging market paradigm of 2022, stop buying/recommending stocks with Negative CF (cash flow), horrible net margins, and/or stocks with great stories that have yet to prove their business model to be profitable. Quality names are trading at great prices – why waste your money (and the money of your followers) on anything less?
Wishing you a prosperous year on the path to financial freedom,