Datadog is one of the fastest growing SaaS companies. But with its stock trading at around 45 times its annual revenue run rate, is it too expensive?
As a B2B (business-to-business) cloud software provider, Datadog Inc (NASDAQ: DDOG) may not be a household name to non-developers and IT engineers. However, it definitely caught my attention.
The monitoring and analytics platform for developers, IT operations, and business users is one of the fastest-growing software companies and has some of the best-in-class metrics to boot.
Despite less than a year as a public company, Datadog’s share price is already double from its first trading day in September 2019. In this article, I share my thoughts on Datadog.
A huge market opportunity
Companies that house their data in the cloud can end up with a complex web of data and information that is difficult to monitor. This is where Datadog’s platform can help. It provides monitoring services across public cloud, private cloud, on-premise, and multi-cloud hybrid environments.
Datadog estimates that the IT Operations Management market will represent a US$37 billion market opportunity in 2023, with the company’s services addressing US$35 billion of that.
Compare that to Datadog’s 2020 first-quarter annual revenue run-rate of around US$524 million, and you can see just how much potential lies ahead.
Growing into its own
Datadog is doing a great job in executing its growth strategy. The software-as-a-service (SaaS) company saw its revenue grow by 98% and 83% in 2018 and 2019 respectively.
In the first quarter of 2020, revenue increased by 87% year-over-year as the number of large customers (with an annual run rate of US$100,000 or more) surged to 960 from 508 a year ago.
Moreover, management expects revenue to increase to between US$555 million and US$565 million for the whole of 2020.
Growing customer base
But, to me, the most appealing thing about Datadog’s business is that the company has some of the best-in-class metrics for SaaS companies.
Datadog has recorded gross margins of 75% to 77% over the past three years, and even had positive GAAP (generally accepted accounting principles) operating income in the first quarter of 2020.
Recording a profit is pretty amazing for a company that is growing as fast as Datadog is.
The reason why Datadog can be so operationally efficient even at this high rate of growth is that it has one of the best-in-class customer acquisition cost (CAC) ratios. The CAC payback period measures how long the company takes to earn back the marketing dollars spent to acquire a new customer. It is calculated as the implied annual run rate gross margin from new customers divided by sales and marketing spend of the prior quarter.
Alex Clayton, general partner at venture capital firm Meritech Capital, recently provided a fantastic chart comparing Datadog’s CAC payback period against other listed SaaS companies (note, the lower the number, the better).
From the chart, you can see that Datadog recovered all its marketing cost to acquire a new customer in around 10 months. That’s only behind video-conferencing software provider Zoom, and well below the 30-month median for SaaS companies.
Customers spending more on its platform
Datadog’s existing customers also continually spend more on its platform. In the first quarter of 2020, Datadog’s dollar-based net retention rate (DBNRR) was above 130% for the 11th consecutive quarter. The DBNRR measures the change in spending for all of Datadog’s customers a year ago compared to the same group of customers today; it includes positive effects from upsells and negative effects from downgrades and customers who leave.
Datadog charges customers base on usage, so the more users (the customer’s employees) that use the platform, the more the customer pays Datadog.
In addition, Datadog has consistently introduced more products on its platform. Datadog uses a land-and-expand growth model. The company first wins customers over to use one product before cross-selling other products to them.
The chart below, taken from Datadog’s IPO prospectus, shows the annual revenue run rate of cohorts (customers that started using the platforms) from 2012 to 2018.
Source: Datadog S-1
As you can see, each colour on the graph fattens over the years. This means that the cohorts are collectively spending more money on Datadog’s platform.
Robust balance sheet
Datadog raised around US$648 million during its September 2019 IPO. As of March 2020, Datadog had US$794 million in cash, cash equivalents, and marketable securities and no debt. This is a great financial position.
In addition, Datadog announced in late May 2020 that it is raising US$650 million through a convertible notes offering. The conversion price of US$92.30 per share represents a 21% premium to the company’s share price at the time of writing.
The offering should further strengthen Datadog’s balance sheet. The convertible price after 5 years should not dilute shareholder interests by too much as well. As the company is already free cash flow positive (more on this below), I expect management to use the new-found cash to make strategic acquisitions to improve its core offering, or invest in R&D to launch new products.
Free cash flow
As mentioned above, Datadog is already generating free cash flow. In fact, the company generated positive operating cash flow in 2017, 2018, and 2019; and had positive free cash flow in 2018 and 2019. In the first quarter of 2020, Datadog had US$19.3 million in free cash flow.
That’s equivalent to a free cash flow margin of 14.7%, decent for a company that is seeing such strong growth.
As the company grows, I expect Datadog’s free cash flow margin to widen and easily settle at 30% or more.
History of successful innovation and new products
Much of Datadog’s success has come from its constant innovation and creation of new products. The firm initially offered just infrastructure monitoring but soon expanded its service to monitor the entire technology stack.
This single pane view of the entire technology stack proved extremely popular and is one of the reasons why the company’s DBNRR is so high.
Going forward, innovation and technology upgrades will be key in ensuring that Datadog maintains its market position in this highly competitive space.
Final words
Datadog has the potential to become one of the top dogs in its industry.
But there are also risks such as execution risk and the threat of competition. It also hard to ignore Datadog’s extremely rich share price: The company’s market capitalisation is around 45 times its annual revenue run rate (based on revenue for 2020’s first quarter). This means that a lot of Datadog’s future growth is already being baked into its share price.
However, if Datadog manages to fulfill its potential and captures just 10% of its market opportunity, I think its future market capitalisation will be much higher than it is today.
Moreover, given its recurring income stream, position as a leading player in its space, high margins, operational efficiency and history of innovation, I think Datadog has a good chance of rewarding shareholders five to ten years down the road.
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.
*Editor’s note: The article mistakenly stated that the free cash flow for the first quarter of 2020 was US$23 million and free cash flow margin was 17.3%. However, the correct figures are 19.3% and 14.7%. The article has since been updated to reflect that.
Investing-disasters that affect individual investors are often preventable through investor education. This is why The Good Investors exists.
I woke up at 6:15am this morning. One of the first few things I saw on the web shook me. Investor Bill Brewster wrote in his Twitter account that his cousin-in-law – a 20 year-old young man in the US – recently committed suicide after he seemed to have racked up huge losses (US$730,000) through the trading of options, which are inherently highly-leveraged financial instruments.
A young life gone. Just like this. I’ve never met or known Bill and his family before this, but words can’t express how sorry I am to learn about the tragedy.
This painful incident reinforces the belief that Jeremy and myself share on the importance of promoting financial literacy. We started The Good Investors with the simple goal to help people develop sound, lasting investing principles, and avoid the pitfalls. Bill’s cousin-in-law is why we do what we do at The Good Investors.
In one of my earliest articles for The Good Investors, written in November 2019, I shared an article I wrote for The Motley Fool Singapore in May 2016. The Fool Singapore article contained my simple analysis on the perpetual securities that Hyflux issued in the same month. I warned that the securities were dangerous and risky because Hyflux was highly leveraged and had struggled to produce any cash flow for many years. I wish I did more, because the perpetual securities ended up being oversubscribed while Hyflux is today bankrupt. The 34,000 individual investors who hold Hyflux’s preference shares and/or perpetual securities with a face value of S$900 million are why we do what we do at The Good Investors.
Whatever that happened to Bill’s cousin-in-law and the 34,000 individual investors are preventable with education. They are not disasters that are destined to occur.
Jeremy and myself are not running The Good Investors to earn any return. Okay, maybe we do want to ‘earn’ one return. Just one. That people reading our blog can develop sound, lasting investing principles, and avoid the pitfalls. “A candle loses nothing by lighting another candle” is an old Italian proverb. We don’t lose anything by helping light the candle of investing in others – in fact, we gain the world. This is why we do what we do.
R.I.P Alex.
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.
Sembcorp Industries (SGX: U96) dominated the business headlines in Singapore last week. The utilities and marine engineering conglomerate announced on 8 June 2020 that it would be completely spinning off its marine engineering arm – Sembcorp Marine (SGX: S51) – through a complex deal.
As part of the deal, there will be an injection of capital into Sembcorp Marine via a rights issue. Prior to the announcement, Sembcorp Marine was already a listed company in Singapore’s stock market, but it had Sembcorp Industries as a majority shareholder.
I won’t be explaining the deal in detail because others have already done so. My friend Stanley Lim has created a great video describing the transaction for his investor education website Value Invest Asia. Meanwhile, another friend of mine, Sudhan P, has written a great piece on the topic for the personal finance online portal Seedly.
What I want to do in this article is to share an observation I have about the state of Sembcorp Industries’ business. I think my observation will be useful for current and prospective Sembcorp Industries shareholders.
The market cheers
On the day after the Sembcorp Marine spin-off was announced, Sembcorp Industries’ share price jumped by 36.6% to S$2.09. So clearly, the market’s happy that Sembcorp Industries can now be a standalone utilities business (the company has other small arms that are in urban development and other activities, but they are inconsequential in the grand scheme of things). It’s no surprise.
Sembcorp Marine’s business performances have been dreadful in recent years. The sharp decline in oil prices that occurred in 2014 – something not within Sembcorp Marine’s control – has been a big culprit. Another key reason – a self-inflicted wound – was Sembcorp Marine’s decision to load up on debt going into 2014. The table below shows Sembcorp Marine’s revenue, profit, cash, and debt from 2012 to 2019:
Source: Sembcorp Marine annual reports
Getting rid of Sembcorp Marine will allow Sembcorp Industries’ utilities business (the segment is named Energy) to shine on its own. But there’s a problem: The economic quality of the Energy segment has deteriorated significantly over time. This is the observation I want to share. Let me explain.
Low energy
There are two key reasons why I think Sembcorp Industries’ Energy segment has gone downhill.
First, over the six year period from 2013 to 2019, the Energy segment’s revenue and power production and water treatment capacities all grew – the power production capacity even increased substantially. But the segment’s profit did not manage to grow. In fact, it had declined sharply. Sembcorp Industries does report a separate profit figure for the Energy segment that excludes exceptional items. But the exceptional items are often gains on sale of assets and/or impairment of asset values. To me, these exceptional items are not exceptional; they reflect management’s day-to-day decision-making in allocating capital.
The table below shows the Energy segment’s revenue, profit, power capacity, and water-treatment capacity in each year from 2013 to 2019:
Source: Sembcorp Industries’ annual reports
Second, the Energy segment’s return on equity has fallen hard from a respectable 19.3% in 2013 to a paltry 5.3% in 2019. Here’s a table illustrating the segment’s return on equity for this time period:
Source: Sembcorp Industries’ annual reports
The sharp fall in the Energy segment’s return on equity, coupled with the decline in profit, suggests that the economic quality of the segment has worsened materially over the past few years.
Some final words
It’s unclear to me how much of the Energy segment’s power and water capacities were actually in operation as of 2013 and 2019. So it’s highly possible that most of the increase in the capacity-figures seen in the period are mostly for projects that are still under development.
If this is the case, then there may still be a big jump in the Energy segment’s profit and return on equity in the future. But if it isn’t, then the business performance of the Energy segment in the past few years is troubling. If the Energy segment’s numbers can’t improve in the future, the overall picture for Sembcorp Industries still looks overcast to me even if Sembcorp Marine is no longer involved.
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.
US stocks have been rising recently despite the US experiencing economic hardship and societal turmoil. Is this a unique case?
Healthy is not the best word to describe the condition of the US right now.
The US accounts for around 28% of all the COVID-19 cases in the world, despite making up just 4% of the global population. Its economy – the world’s largest – officially entered a recession in February this year, and its current unemployment rate of 13.3% is significantly higher than what it was during the depths of the Great Financial Crisis of 2008-09. The US is also currently in conflict with the world’s second largest economy, China, over multiple issues. Making matters worse for America, the unfortunate death of George Floyd in May while in police custody has sparked large-scale civil unrest across the country over racism.
And yet, the NASDAQ index closed at a record high on 10 June 2020. Meanwhile, the S&P 500 is today just a few percentage points below its record high seen in February 2020 after bouncing more than 37% from its coronavirus-low reached in March.
This massive disconnect between what’s going on in the streets of America and its stock market has left many questioning the sustainability of the country’s current stock prices. Nobody has a working crystal ball. But I know for sure that this is not the first time the US has stumbled.
1968 is widely recognised as one of the most turbulent years in the modern history of the US. During the year, the country was in the throes of the Vietnam War, prominent civil rights activist Martin Luther King Jr and presidential hopeful Robert F. Kennedy were both murdered, and massive riots were taking place. It was a dreadful time for America.
How did the US stock market do? The table below shows the S&P 500’s price and earnings growth with January 1968 as the starting point. I have a few time periods: 1 year; 5 years; 10 years; 20 years; and 30 years. You can see that growth in the earnings and price of US stocks over these timeframes have been fair to good.
The following are charts of the S&P 500’s performance over the same time periods, for a more detailed view:
Source: Robert Shiller data
It’s worth noting too that the S&P 500’s CAPE (cyclically-adjusted price-to-earnings) ratio in January 1968 was 21.5. This means that the rise in US stocks in the time periods we’ve looked at were not driven by a low valuation at the starting point. Today, the S&P 500’s CAPE ratio is 28.5, which is higher, but not too far from where it was in January 1968. (The CAPE ratio divides a stock’s price by its inflation-adjusted 10-year-average earnings)
I’m not trying to say that US stocks will continue to rise from here. A new bear market may start tonight, for all I know. I’m just trying to show two things.
First, stocks can rise even when the world seems to be falling apart. What we’re seeing today – the huge disconnect between Main Street and Wall Street – is not unique. It has happened before. In fact, I’ve written about similar episodes that occurred in 1907 and 2009. Second, we should approach the future with humility. Let’s assume we can travel back in time to the start of 1968. If I told you then about the mess the US would be entering, would you have guessed that, with a starting CAPE ratio of 21.5, US stocks would be (a) 11% higher a year later and (b) 46% higher five years later? Be honest.
No one knows what’s going to happen next. All past crashes look like opportunities, but every future one seems like a risk. There are also always reasons to sell. The best way we can deal with an uncertain future in our investing activities is to adopt a long time horizon, and have a sound investment process in place.
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.
The best articles we’ve read in recent times on a wide range of topics, including investing, business, and the world in general.
We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.
Do subscribe for our weekly updates through the orange box in the blog (it’s on the side if you’re using a computer, and all the way at the bottom if you’re using mobile) – it’s free!
But since our readership-audience for The Good Investors is wider than our subscriber base, we think sharing the reading list regularly on the blog itself can benefit even more people. The articles we share touch on a wide range of topics, including investing, business, and the world in general.
Here are the articles for the week ending 14 June 2020:
But in his spare time, Roth moonlights as a “superforecaster”— a member of a team of ordinary people who make surprisingly accurate predictions for the forecasting firm Good Judgment, Inc. In recent months, businesses, governments and other institutions have worked with superforecasters like Roth to help them understand how the COVID-19 outbreak might unfold.
That a group of semi-professional forecasters would somehow have accurate insight into anything as complex and important as the coronavirus pandemic sounds like the stuff of science fiction, or even ancient history—like the seers of old who told fortunes to kings and nobles. But the team behind Good Judgment, Inc. and the organization it spun off from (the research initiative Good Judgment Project) say they have established a rigorous system for identifying talented forecasters and sharpening their abilities…
… It’s unlikely that superforecasters like Roth could ever fully replace subject-matter experts. Michael Jackson, an associate scientific investigator at Kaiser Permanente Washington Health Research Institute, cautions that superforecasters are a “black box,” meaning their less-than-scientific methods make it impossible to vet their work in the same way that a scientist’s output would undergo peer review. And Philip Tetlock, a professor at the University of Pennsylvania and a co-founder of Good Judgment, acknowledges that there are times in which expertise is crucial (for example, he notes that some public health experts warned about the possibility of a coronavirus pandemic early in the outbreak.)
However, Tetlock argues that superforecasters have skills that experts may not: for example, they may also be more flexible than traditional scientists, because they’re not bound to a particular discipline or approach. Their predictions incorporate research and hard data, but also news reports and gut feelings. That way of working may increase their overall accuracy, says Tetlock…
… Superforecasters aren’t just smart, Tetlock says; they also tend to be actively open-minded and curious. They’re in “perpetual beta” mode, as he puts it in his book on the topic, Superforecasting: The Art and Science of Prediction— always striving to update their beliefs and improve themselves.
The Stoics are saying there are no good or bad events, there’s only perception. Shakespeare encapsulated it well when he said, “Nothing either good nor bad but thinking makes it so.” Shakespeare and the Stoics are saying that the world around us is indifferent, it is objective. The Stoics are saying, “This happened to me,” is not the same as, “This happened to me and that’s bad.” They’re saying if you stop at the first part, you will be much more resilient and much more able to make some good out of anything that happens…
… Don’t set your mind on things you don’t possess as if they were yours, but count the blessings you actually possess and think how much you would desire them if they weren’t already yours.
The DNA molecule was composed of the traditional sugar backbones and nucleotide pairs, but rather than the well-known right-handed spiral of the double helix structure, famously discovered by Watson and Crick in 1953, Wells’s polymer spiraled in the opposite direction, giving it a zigzag appearance.
Whether this bizarre form of DNA existed in cells and had any function, and what that might be, was hotly debated for nearly half a century. But research has recently confirmed its biological relevance. So-called Z-DNA is now thought to play roles in cancer and autoimmune diseases, and last year scientists confirmed its link to three inherited neurological disorders. Today, molecular biologists are beginning to understand that certain stretches of DNA can flip from the right- to the left-handed conformation as part of a dynamic code that controls how some RNA transcripts are edited. The hunt is now on to discover drugs that could target Z-DNA and the proteins that bind to it, in order to manipulate the expression of local genes.
In “Breaking the Silence,” an open letter that has generated both internal and external praise since it was published on June 1, the Chicago-based African-American president of a firm with more than $900 billion under management wrote of a decades-old encounter with police in a Chicago suburb.
“It was profiling, pure and simple,” he wrote of the incident in which an officer unholstered his firearm after pulling him over for no other reason than Thomas being a black man in a white neighborhood. Unfortunately, this wasn’t an isolated incident; he has suffered numerous similar indignities throughout his life. In the wake of the recent killings across the United States of three African-Americans in separate incidents that have generated worldwide protests demanding an end to racial inequities, Thomas was moved to do what many feel needed to be done: “break the silence as it pertains to issues of prejudice and discrimination” and give voice to the pain.
Ser Jing here: The link above brings you to a podcast hosted by Anthony Pompliano featuring investor Cullen Roche. Roche writes an excellent blog calledPragmatic Capitalism that offers his thoughts on how the modern monetary system works. In the podcast, Roche talks about his views on how the Federal Reserve actually works, and he shares his thoughts on why a lot of common beliefs about the US’s central bank (such as “money printing” will cause hyperinflation, and the Fed has manipulated interest rates to unsustainable lows) are wrong. Some of Roche’s commentary fly over my head because I don’t have a good grasp on the monetary system or the inner-workings of the Federal Reserve. But I still find Roche’s views important to note to gain a broader perspective on money.
My what is I like to find the most innovative companies of our time and I like to make sure they’re not just R&D firms, or they’re not just a hope and a dream. They’re actually real-world companies delivering outstanding solutions, often disrupting the industries in which they are participating; but they’re real innovators and they could be potentially big-time innovators. Like maybe one day they’d grow up and be Amazon.com.
Those are my whats. I’ve always loved those companies. I think you and I should spend almost all of our time, if we’re trying to beat the market and we care enough to select stocks, I think we should be spending a lot of our time, anyway, looking at those kinds of companies. That’s my what.
My how is that I tend to buy and not really to sell.
I try to get in before the vast majority of others and out well after the vast majority of others. That’s a quote that I’ve sometimes used in the past — one of my maybe legacy lines one day that I’m hoping to just convey — how we do the “how of Rule Breaker Investing.” In before the vast majority of others. Out well after the vast majority of others and it’s that second part that’s so key. That’s kind of our how.
And what I said in that meeting 10 years ago was, “I think that’s why this approach works, because a lot of people who might go for innovators think that those are really high-priced stocks, or they’re momentum stocks, or you need to figure out when to sell those because they’re going to collapse, probably, at some point. I mean, you need to act in a volatile manner around volatile innovators.”
But we, instead, on this podcast and in my services Motley Fool Stock Advisor and Motley Fool Rule Breakers, I’ve got a scorecard almost two decades long, now, of stocks where we basically bought them and then kept holding. We did the opposite of how people think they should approach innovators.
And I think, because that puts us in a small corner of the big room of the investment world, there are not many others that have painted themselves into that little corner where we are. We’re kind of lonely, there, and that’s great news for you and me because most of the rest of the world will not adopt this investment approach and so that’s our what and that’s our how and when you put those two things together you have, I hope, a market-beating strategy you can use the rest of your life.
In another example of casual cosmic malevolence, astronomers published a movie last month of what they said was a black hole shooting blobs of electrified gas and energy into space at almost the speed of light.
From a distance — quite a distance, of some 10,000 light-years — the black hole looked like a cosmic pop gun, propelling puffs of light across the sky. Up close … well you wouldn’t want to be up close, as clouds of sterilizing radiation a trillion miles wide swept by…
… “Consequences can be indirect,” she said. “A huge increase in cosmic rays during the Pliocene might have been indirectly responsible for the extinction of some ocean animals — not due to irradiation but due to damage to the ozone layer they created. So maybe crossing the path of a jet could indeed create a massive extinction, though we are a bit speculating here.”
As the bubbles traveled outward, they lit up the thin interstellar gas with a traveling light show.
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.
One of my favourite investing articles is an old piece, written in February 2008, by The Motley Fool’s co-founder, David Gardner. It had the provocative title, The Greatest Secret of All, and an equally provocative lede (emphasis is his):
“Welcome to my article. I’m glad you found it, because it is your lucky day, dear Fool: The greatest secret to easy riches in the stock market is contained right here, below.”
The article does contain the greatest secret in investing, and I implore all of you to read it. I’ll come back to his piece and provide a link to it later. For now, let’s turn to my girlfriend’s investment portfolio.
The portfolio
In early 2019, my girlfriend wanted to build a portfolio of stocks for herself. We started having long conversations about what she can do and how she should be building the portfolio. Eventually, she settled on a list of stocks in the US that she was really keen on, and she made the purchases on the night of 8 March 2019.
The list of stocks are shown in the table below, along with their initial weightings. I merely acted as a sounding board – the stocks were bought by her. She made the final call and the “Buy” mouse clicks.
From the get-go, the portfolio did really well, producing a gain of 20% in just a few short months. There was a brief swoon from mid-July to early-October, but then things picked up again. Her stocks ended up charging to an overall gain of 36% in mid-February 2020. That was when all-hell broke loose.
The fall, and the aftermath
The S&P 500 in the US – the country’s major stock market index – hit a peak on 19 February 2020, before fears over COVID-19 started ripping across the market. By 23 March 2020, the S&P 500 had declined by 34% from peak-to-trough.
My girlfriend’s portfolio was not spared – it tumbled by 29% over the same period. All her previous gains were wiped out in the fall. The portfolio even dipped into the red.
Here’s a chart of the performance of my girlfriend’s portfolio (the blue line; without dividends) and the S&P 500 (the red line; with dividends) from 8 March 2019 to 8 June 2020:
Source: Google Finance and Yahoo Finance
As of 8 June 2020, my girlfriend’s portfolio has a 50% gain from its initial value on 8 March 2019, and has comfortably surged past the previous peak seen in February 2020. Meanwhile, the S&P 500 has rebounded strongly from its 23 March 2020 low, but it’s still a little off its high.
The greatest secret, revealed
Some of you may be thinking that my girlfriend had made significant changes to her portfolio in March 2020 that resulted in the strong gains seen in the right-hand part of the chart above. Not at all. Her portfolio had zero changes during the COVID-19 panic. In fact, she has made no changes to her portfolio since she first purchased her stocks on 8 March 2019.
This brings me back to David Gardner’s article, The Greatest Secret of All. The secret that David is referring to is this:
“Find good companies and hold those positions tenaciously over time to yield multiples upon multiples of your original investment.”
The word “tenaciously” needs highlighting. There was a painful period earlier this year when my girlfriend’s portfolio was in the red. She needed tenacity to hold on. To her credit (and it’s all her credit!), she held on. She was forward-looking and never gave in to the prevailing pessimism about COVID-19.
Yes, COVID-19 – and the economic slowdown that has happened globally as a result – was and still is painful for all of us. But she was confident that “this too, shall pass.” Tomorrow will be a brighter day.
She was also confident in the long-term futures of her companies. If you look at the names, these are companies that are building the world of tomorrow. There’s robotic surgery (Intuitive Surgical); DNA analysis and precision medicine (Illumina); e-commerce (Amazon, Shopify, MercadoLibre); digital payments (Mastercard, PayPal, Visa); streaming (Netflix, Spotify); and cloud computing (DocuSign, Paycom Software, Veeva Systems, Twilio etc). There’s more, but I think you get the drift.
What’s next?
The story of her portfolio is not over yet. Only 1 year and 3 months have passed – that’s way too short a time to come up with any high-probability insights. A new bear market may be just around the corner. It’s not our intention to take a victory lap.
But what has happened to my girlfriend’s portfolio throughout the COVID-19 situation – because of her tenacity in being actively patient – is worth bringing up. Because, 10 years from now, her portfolio could very well be another real-life example of David Gardner’sgreatest secret in investing.
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, the author, own all the shares mentioned here (except for Spotify). I will be making sell-trades on most of the stocks mentioned here for reasons that are explained in this article.
With the S&P 500 now up year-to-date, is it a good time to short the market?
On 8 June 2020, the US stock market’s NASDAQ index closed at an all-time high, while the S&P 500 showed a profit for the year. There’s a big mismatch between what is going on in the American stock market and economy, so some investors may be asking if now’s a good time to short stocks.
(To short a stock means to invest with the view that its price will fall.)
These are unprecedented times. But before you start shorting stocks, here is a reminder of the risks of shorting.
“The market can remain irrational longer than you can remain solvent”-John Maynard Keynes
I think its important to remind ourselves that shorting a stock can provide an upside gain of 100%, but it has unlimited downside risk.
If you short a stock and it climbs by more than 100%, you would have lost more than 100% of your starting capital. And that may happen more often than you imagine. Hertz, the car rental company that filed for bankruptcy protection last month, has seen its share price climb by more than 600% from its 26 May 2020 low.
Let’s also not forget that even if your short position ultimately ends up correct, you will need to endure stomach-churning volatility. This could cause you to have to put up much more capital – to maintain the short position – in order to earn a small return. In addition, if the stock climbs and you run out of cash to back your position, your broker could force-close your position, leaving you with a loss.
It may also take years for a short position to eventually pay off, giving investors a very small annualised return if the stock does fall.
Professional investors are not immune to huge losses
Bill Ackman’s Herbalife bet comes to mind.
Herbalife is a company that sells nutritional products through a multi-level marketing scheme. In this marketing model, consumers can earn a commission by referring friends to purchase the company’s products.
Ackman believed that Herbalife was so aggressive in recruiting sellers that most of its sales came from people who wanted to earn from the commissions, and not because they wanted to use the products they bought. These “customers” simply bought the products so that they could try to sell them and earn commissions.
Ackman started his short on Herbalife in 2012 and gave a now-infamous 3-hour long presentation in 2014 on why he believes the company is a pyramid scheme. A pyramid scheme is effectively a scheme where only the top of the pyramid gets rich at the expense of those at the bottom of the pyramid.
Although I personally believe that Herbalife’s marketing methods were aggressive and could be labelled as unethical, it wasn’t illegal. Ackman’s Herbalife bet was also made more complicated when billionaire investor Carl Ichan took a long position and snapped up over a quarter of the company’s shares.
First of all, it is extremely difficult for Ackman or the authorities to prove that Herbalife was operating a pyramid scheme as long as there was a product at the end of it all. In this case, even though many Herbalife distributors ended up buying nutritional products that they did nor consume, the company can say it was legitimately selling the products to them.
It may not be an ethical business (in my eyes) but the authorities did not think it was a fraudulent one either. Ackman’s fund, Pershing Square, ended up losing US$1 billion on its short bet on Herbalife.
Short (but painful) squeeze
Short positions may also face sudden spikes in a stock’s price arising from a short squeeze. A short squeeze happens when a stock rises in price, forcing short sellers to close their positions. This, in turn, causes the stock price to rise further, leading to more short sellers being forced to close their positions.
The spike in price can be sudden and swift, and many short sellers will have no choice but to close their positions with a hefty loss.
An example that comes to mind is Tesla’s stock.
Tesla has been one of the most shorted stocks in recent years. However, there have been numerous days when Tesla’s stock has seen a sharp and swift rise in price.
Some of these sharp rises were due to good news coming from the company. But it’s likely that the increases also had contributions from short sellers being forced to close their positions.
Final words
We are living in strange times. The S&P 500 is now showing a positive return so far in 2020, while the NASDAQ is above its pre-COVID-19-crisis level. With many economies still in partial lockdown, investors are wondering why stock prices are not reflecting the current economic contraction.
However, if you are tempted to short the market, it is important to know the risks involved.
Shorting can be a profitable activity, but is also filled with risks. Personally, as a long-term investor, instead of trying to make a little money shorting stocks, I prefer buying quality stocks for the long term where the odds of success are much more heavily stacked in my favour.
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.
Companies that have a great view on how we live, work, spend, and play have recently shared important clues on how a post COVID-19 world could look like.
The title of this article is a topic that I think many investors badly want to know.
I don’t think anyone has a firm answer. But we can get important clues from the comments that some companies have shared in recent times. I’m referring to companies that have a great view on how we live, work, spend, and play.
“As COVID-19 impacts every aspect of our work and life, we have seen two years’ worth of digital transformation in two months. From remote teamwork and learning, to sales and customer service, to critical cloud infrastructure and security, we are working alongside customers every day to help them stay open for business in a world of remote everything. There is both immediate surge demand, and systemic, structural changes across all of our solution areas that will define the way we live and work going forward.”
“Throughout the quarter, we saw consumption continue to increase across the platform and growth of the number of hosts, containers metrics traces and logs, for example, have remained consistent with historical trends.
We started to see some negative effects in impacted industries such as travel, hospitality and airlines. But we’ve also seen substantially increased usage from other categories such as streaming media, gaming, food delivery and collaboration, as these customers scaled up their operations in this environment.
We also saw a surge of usage and surge in accounts in March in response to COVID that we expect could be more transitory in nature and may normalize over time.”
“In the past month, there has been unprecedented demand for our products and services. Our transactions are up 20% year-over-year, with branded transactions up over 43% more than double pre-COVID levels in January and February. On May 1st, we had our largest single day of transactions in our history, larger than last year’s transactions on Black Friday or Cyber Monday.
Our net new actives hit record highs in April, surging over a 140% from January and February levels, averaging approximately 250,000 net new active accounts per day. For the month of April, we added an all-time record of 7.4 million net new customers. I don’t want to lose sight of the fact that we also had a record Q1 adding 10 million net new accounts, but that will pale in comparison to the 15 million to 20 million net new active accounts we anticipate adding in Q2…
… We had a very strong January and February, with FX-neutral revenues growing by an average of 18% and TPV growing at 26%. We began to see some COVID-19 impacts in late February, but the strength of our overall business outweighed cross border weakness coming out of China. However, all that changed as we exited the first week of March.
Shelter-in-place and social distancing became the norm across the globe, and as one economy after another effectively shut down, we saw a substantial revenue decline, predominantly in our travel and ticketing verticals. Some of our important customers, including Uber, Airbnb and Live Nation saw rapid decreases in transaction volumes…
… As I mentioned earlier, we began to see a very noticeable shift in our results toward the end of March and throughout April. We saw dramatic increases in our daily net new actives and overall engagement levels. Our daily number of transactions accelerated throughout the month growing from the beginning of April until month end by 25% with 7.4 million net new actives, record engagement and transaction volumes and 20% revenue growth. I would characterize April is perhaps our strongest month since our IPO.”
“We’ve seen our customers rise to the occasion too. While shelter in place orders have slowed foot traffic to our sellers, they found new ways to keep their doors open, retain staff and serve customers. Retailers, wine shops and QSRs launched online ordering by building websites in less than a day for delivery and curbside pickup. Larger full service restaurants opened community markets to sell raw ingredients, produce and food staples through online stores, even Michelin Star restaurants like Chez Panisse in Berkeley.
Distilleries and taylors shifted to selling personal protective equipment like hand sanitizer and masks. Hairdressers and beauticians moved to video appointments to advise on self-styling. Over the past six weeks we’ve also seen Cash App customers come together like never before. Folks are donating the strangers in need through social media, fundraising for charities, small businesses and churches and tipping artists during online performances…
“While GMV through the point-of-sale (POS) channel declined by 71% between March 13, 2020 and April 24, 2020 relative to the comparable six-week period immediately prior to March 13, as most of Shopify’s Retail merchants suspended their in-store operations, Retail merchants managed to replace 94% of lost POS GMV with online sales over the same period. Retail merchants are adapting quickly to social-distance selling, as 26% of our brick-and-mortar merchants in our English-speaking geographies are now using some form of local in-store/curbside pickup and delivery solution, compared to 2% at the end of February.”
“A great example of this is what we did with the state of Illinois, which was a notable win in the quarter for both workforce and customer identity. With the onset of the pandemic, Illinois needed to ensure it could securely manage its remote workers and secure the identity and access of several state agencies. The state had numerous disparate legacy identity systems across its agencies, which caused friction for its employees, contractors and citizens. Illinois selected Okta to be their identity standard, which will streamline their operations with a single unified identity platform.
With Okta’s customer identity solutions, Illinois’ citizens will have a secure, seamless experience when accessing their government resources. And with Okta’s workforce identity, the state’s employees and contractors will be able to more efficiently do their jobs…
… In just 36 hours, we helped FedEx deploy the Okta Identity Cloud to enable more than 85,000 remote and essential employees to connect to critical applications amid increased demand during the crisis…
… We were one of the first companies to host a large and virtual event, two events if you include our Investor Day. It was an unexpected and challenging task, but both events were incredibly successful, and our customer and investor feedback was amazing. We had nearly 20,000 registrations for Oktane20 Live, which is over 3 times what we had been expecting for the in-person event…
… As we look forward to the rest of this year and beyond, when this crisis is over, we don’t expect organizations to revert to their prior ways of working. We have no doubt that a much higher percentage of workforces will be connecting remotely, and we see that as an inevitable long-term trend.”
“I think if you look at some of the metrics around commerce in North America, I know that e-commerce has been, kind of, trending up from 10%, 11%, 12% over the last few years of total commerce. I think it just jumped to something like 25%, 27% of all commerce. That trend is not going away.”
“Looking at things, a different way, our newly booked room nights, which exclude the impact of cancellations, were down over 60% year-over-year in March and down over 85% in April. This gives you a clear indication of how much our business is currently impacted by this crisis.
That being said, while the virus’ impact on travel is unprecedented, I am confident that this crisis will eventually end and people will travel again. Travel is fundamental to who we are and while it may take some time to return to pre-COVID-19 levels, we will get there eventually. And then we’d expect travel to continue to grow thereafter…
“New bookings revenue for full second quarter may vary from April’s results depending upon the level of travel demand and accommodation availability we experience in May and June. As Glenn noted, we’re seeing some stability on newly booked room night growth trends with the year-on-year decline rate being quite consistent for our April after reducing rapidly through the first quarter. We believe that domestic travel will rebound sooner than international travel as we expect travelers to look to their home country or region first for safe travel option.”
“The effects of the pandemic have been far-reaching and the world is looking to life sciences companies for solution. The industry is less affected financially than many others and remains relatively strong overall, but it is certainly a time of significant change as many of the industry processes become more virtual. Healthcare providers and patients are delaying many non-essential visits and elective procedures. When comparing February to April in the US using Crossix data, doctor visits were down by more than 50%. This is impacting some life sciences companies more than others depending on their product portfolio.
Many clinical trials have been delayed to avoid nonessential patient visits to doctors, in-person visits by sales reps or clinical research associates to doctors have also largely stopped. These changes are causing patients, doctors and the industry to rapidly adopt digital strategy. Necessity is creating innovation. Using Crossix data, we see that telemedicine increased rapidly in the US from less than 1% of doctor visits in February to more than 30% of visits in April. Doctors and patients are getting used to a mix of in-person and digital interactions and are finding it productive.
Using Veeva Pulse data from Veeva CRM, we see that in the US remote meetings between pharma and doctors with CRM Engage are up more than 30 times, and Approved Email communications are up more than 2 times from February to April. Doctors are telling us they find digital meetings effective and they look forward to a mix of in-person and digital interactions once things get back to normal. It’s good to see the healthcare systems and the life sciences industry evolving so rapidly. It was a very busy quarter for Veeva.”
““People, after having been stuck in their homes for a few months, do want to get out of their houses; that’s really, really clear,” Airbnb Inc. Chief Executive Officer Brian Chesky said in an interview. “But they don’t necessarily want to get on an airplane and are not yet comfortable leaving their countries.”
Airbnb saw more nights booked for U.S. listings between May 17 and June 3 than the same period in 2019, and a similar boost in domestic travel globally. The San Francisco-based home-share company is seeing an increase in demand for domestic bookings in countries from Germany to Portugal, South Korea, New Zealand and more. Other companies, including Expedia Group Inc.’s Vrbo and Booking Holdings Inc. are also seeing a jump in domestic vacation-rental reservations…
… International sojourns usually planned months in advance are being replaced with impulsive road trips booked a day before and weekend getaways are turning into weeks-long respites, Chesky said. Previously, a New Yorker might have headed to Paris for a week in June. Now they are going to the Catskills for a month. “Work from home is becoming working from any home,” he said.”
“Especially, from January 20, 2020 until February 20, 2020, local governments issued strict control measures… Shortly after February 20, 2020, when orderly resumption of work took place across the country, an increasing number of restaurants started to resume their operations while demand from consumers also gradually recovered. However, as some of consumer demand continued to be negatively impacted by hygiene concerns and quarantine measures, the ongoing closure of universities, and work-from-home policies that applied to many of our high frequency consumers, the order volume still had not fully recovered to its normal levels by the end of March 2020…
… In spite of the short-term negative impacts, we strongly believe that the COVID-19 pandemic will play a positive role in the industry’s long-term development. On the consumer side, the pandemic has further accelerated the cultivation of consumption behavior, helping to further educate some of our targeted potential consumers in a positive way… Notably, we have seen increasing consumer preference for high ticket size categories during the pandemic due to the increasing adoption of food delivery for formal meals, further diversification of high-quality supplies on our platform and growing preference for branded restaurants…
… On the merchant side, the overall catering industry was severely disrupted in the first quarter of 2020… More notably, the pandemic has further accelerated the digitization process, especially for many branded restaurants with high quality supply, which have traditionally focused on in-store dining instead of delivery services. In the first quarter of 2020, a large number of premium restaurants, highly-rated restaurants, chain restaurants, Black Pearl restaurants and five-star hotel restaurants, which did not have or had very limited food delivery services, initiated food delivery operations as their primary vehicle for business operations due to the pandemic. Participation by these restaurants increased high-quality supply on our platform in the long term, while we reinforced our importance to small- and medium-sized independent restaurants as food delivery almost became their sole source of income during the pandemic.
On the delivery front, although delivery capacity was not the bottleneck for our food delivery business during the pandemic, delivery cost per order increased both on a quarter-over-quarter basis and a year-over-year basis as a result of the increased incentives paid to delivery riders working during Chinese New Year and pandemic situations, additional costs associated with anti-epidemic measures, and the decline in order density. However, the pandemic has accelerated the adoption of new delivery models and stimulated technological innovation. As a leader and promoter of on-demand delivery, we pioneered the launch of contactless delivery services, which received widespread acceptance and recognition from consumers, merchants and local governments. In addition to helping to mitigate the hygiene risks for both consumers and delivery riders, the contactless delivery model improves delivery efficiency and creates more opportunities for the exploration of diversified delivery models and new technology for autonomous delivery…
… During the pandemic, our in-store business was more severely challenged in comparison to the food delivery segment, and its recovery was noticeably lagging behind that of the food delivery segment. As the majority of the in-store service categories are classified as discretionary or entertainment-related services, which usually involve close contact with others and/or large crowds, both supply and demand remained low in the first quarter of 2020 due to consumers’ hygiene concerns and local governments’ restrictions…
… As the leading platform in local services, we began to work with local governments in March 2020 to launch the Safe-Consumption Festival and issued vouchers to consumers to use in local services, especially in restaurant dining, which sustained the most impact during the pandemic. We believe that consumer vouchers could not only stimulate one-off consumptions, but also have strong leverage effects that stimulate the recovery of the overall consumption demand in relevant regions and industries….
… While local accommodation and business travel activities, especially in lower-tier cities, have started to gradually rebound at a faster pace along with the general recovery process, consumers were still taking conservative measures and postponing travel-related activities and expenditures even after the peak of the pandemic. To further support industry recovery, we leveraged our platform capabilities and launched the Safe-Stay Program. Under the Safe-Stay Program, we established precautionary measures and increased service capabilities for our partner hotels, such as the adoption of strict health precautions for all employees and consumers, close tracking of consumer information, free booking cancelations, and discounts for additional nights.”
“We engaged a new public sector customer, the Department of Labor in one of the largest U.S. states to help transform its previously complex and lengthy process for handling emergency unemployment benefit. Supported by DocuSign eSignature, the department distributed over $500 million in benefits to more than 500,000 residents in less than one week. We enabled hundreds of U.S. national and regional financial institutions to accept applications for Small Business Administration loans more efficiently. In one of those large banks, we were involved with over 0.5 million loan applications, 75% of which were signed in less than 24 hours.
We worked with a regional telecom provider using DocuSign Intelligent Insights, which is our contract analytics tool to analyze potential pandemic-related risks in thousands of their supplier contracts. Finally we helped a European telemedicine provider issue e-prescriptions and online sick leave certificates by using our video identification capability to confirm the patients’ identities…
… Some of the healthcare opportunities were big. If you think about the situation where you’re trying to — you’re now trying to do COVID-19 testing and you’ve never been an organization that did that kind of testing before, and now you say, “I got to figure out a way to get people’s information and get them to fill out forms, Oh! but I don’t want to touch them, I don’t want to touch anything they’ve touched, I also need a digital solution for doing that.” And we had sales cycles that happened in that in a matter of days, where people came to us, explained that business need that they had, or that healthcare need that they had and we were able to get up and running that use case.”
“As you can imagine, customers in the hospitality and travel have exhibited very unusual patterns during this period. First, there were spikes in volume as airlines and hotels dealt with rebookings and canceled flights during the transition from pre-COVID-19 into travel restrictions and shelter-in-place protocols. Then, there was a sharp decline as business slowed. Another example is that ridesharing saw a large decline during this time, with offsets in many cases by sharp increases in demand for food delivery, curbside pickup and retail logistics. In addition, telehealth and work-from-home contact centers saw a pickup of adoption during this time.
While we are cautiously optimistic, no one can predict what exactly will transpire in the back half of the year given the uncertainty of the macroeconomic environment…
… We’ve seen companies across multiple industries adapt in real time due to COVID-19. Digital transformation projects that could have taken years such as transitioning from an on-trend contact center to the cloud instead took a weekend. Developers and companies big and small got to work, reconfiguring the world for a work-from-home and nearly 100% e-commerce reality.
Let me give you just a few use cases across various industries that we’ve helped our customers win over the last couple of months. With shelter-in-place and social distancing going into effect, demand for telehealth solutions has soared. Virtual care became a new reality for doctors, nurses, clinicians and millions of patients around the world. And Epic, the company that supports the comprehensive health records of 250 million people, mobilized to build its own telehealth platform powered by Twilio’s programmable video. The solution allows providers to launch a video visit with a patient, review relevant patient history and update clinical documentation directly within Epic.”
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.
What we can learn from an investor who produced an annual return of 23% for 47 years.
I first learnt about Shelby Cullom Davis sometime in 2012 or 2013. Since then, I’ve realised that he’s seldom mentioned when people talk about the greatest investors. This is a pity, because I think he deserves a spot on the podium alongside the often-mentioned giants such as Warren Buffett, Benjamin Graham, Charlie Munger, and Peter Lynch.
Davis’s story is well-chronicled by John Rothchild in the book, The Davis Dynasty. Davis started his investing career in the US with US$50,000 in 1947. When he passed away in 1994, this sum had ballooned to US$900 million. In a span of 47 years, Davis managed to grow his wealth at a stunning rate of 23% annually by investing in stocks.
There are wonderful investing lessons found in The Davis Dynasty and there are three that I want to share in this article.
Lesson 1: It’s never too late to start investing if you do it correctly
Warren Buffett was a whiz kid. He started his own investment partnership at the ripe “old” age of 26 in 1956. But not everyone starts young like Buffett. If you think you’re too old to start investing because you need to draw upon your savings as you approach retirement, take heed. Davis only started his investing career at 39 – without prior experience – and went on to build an immense fortune.
The secret of Davis’s success is that he started investing with a sound process. He was an admirer of Benjamin Graham, Buffett’s revered investing mentor. Just like Graham, Davis subscribed to the discipline of “value investing”, where investors look at stocks as part-ownership of businesses, and sought to invest in stocks that are selling for less than their true economic worth. Davis’s preference was to invest in growing and profitable companies that carried low price-to-earnings (P/E) ratios. He called his approach the ‘Davis Double Play’ – by investing in growing companies with low P/E ratios, he could benefit from both the growth in the company’s business as well as the expansion of the company’s P/E ratio in the future.
Davis also recognised the importance of having the right behaviour. He ignored market volatility and never gave in to excessive fear or euphoria. He took the long-term approach and stayed invested in his companies for years – even decades, as you’ll see later –through bull and bear markets. Davis’s experience shows that it is a person’s behaviour and investing process that matters in investing, not their age.
Singapore’s statutory retirement age is currently 62. For those who are 65 at the moment, the average life expectancy is 21.1 years. So, most people approaching retirement, or even those who are already retirees, will likely still have decades to invest. If they can use a portion of their retirement savings (and only just a portion!) to invest in stocks with the right behaviour and process, the investments could provide an additional income stream through dividends and/or a better tomorrow through capital appreciation. The stock market will almost surely decline steeply from time to time (volatility is normal!). But investors with a sound process, regardless of age, should still stand a great chance of coming out ahead.
Lesson 2: Buying and holding works
In The Davis Dynasty, John Rothchild wrote that the foundation for Davis’s wealth was built on a few stocks that he had bought in the 1960s and held till 1992. Notable examples included: (1) A US$641,000 purchase of Japanese insurer Tokio Marine & Fire in 1962 that grew to US$33 million; and (2) shares of American insurer American International Group that he began buying in 1969 that grew to US$72 million.
The journey was rough for Davis. His portfolio shrunk from US$50 million to US$20 million during the vicious bear market that US stocks experienced in the early 1970s. But he watched unmoved. Instead of selling, Davis bought shares of undervalued companies very aggressively during the bear market, while holding on to the stalwarts he had purchased in the 1960s.
Davis knew that the companies he had invested in were still solidly profitable with bright growth prospects. He saw no reason to sell their shares during the bear market. He was confident that their value would be far greater in the future, because his investment focus was on companies with excellent management, good returns on capital, and a strong balance sheet. These are attractive company-traits for long-term investors.
His experience during the 1970s bear market, and the eventual wealth he built, is a great reminder that a long-term buy-and-hold approach to investing will work if your investing process is sound.
Lesson 3: The world is your oyster
In 1962, Davis travelled to Japan and learnt about Japanese insurance companies that had solid operations because of governmental support. He used the knowledge gained from his investing experience in the US to analyse the Japanese insurance companies.
At the time, American investors only had eyes for American companies. Their thinking was that investing in foreign stocks was too risky. But Davis thought differently. He saw value in the Japanese insurance companies. He ended up investing in four insurers for around US$2 million in total. They are: Tokio Marine & Fire; Sumitomo Marine & Fire; Taisho Marine and Fire; and Yasuda Fire & Marine. Davis held them for more than three decades. By 1992, they were worth a combined US$75 million.
Davis was not the only American investor, decades ago, who dared to venture abroad. Sir John Templeton, an investing legend who achieved a 15.4% annualised return from 1955 to 1992, was also a renowned global stock picker.
“The concept of geographical diversification is particularly important for Singapore investors. Look at the stocks in our local stock market benchmark, the Straits Times Index. There’s no good exposure to some of the important growth industries of tomorrow, such as cloud computing, DNA analysis, precision medicine, e-commerce, digital advertising, and more.”
There are risks associated with international investing and we should not be blind to them. Understanding an overseas-based company may be tougher. Currency fluctuations can also hurt our returns. But these risks can be mitigated by finding great companies to invest in. We shouldn’t constrain our investing activities by geography.
Final word
I highly recommend John Rothchild’s book, The Davis Dynasty. There’s so much more about investing that we can learn from Shelby Cullom Davis’s life experiences than what I’ve covered here. But if I were to summarise what I’ve shared in one short sentence, it will be this: Invest for the long run with the right process, and never let age or geography dictate your investing opportunities.
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.
A company that allocates capital well will compound shareholder wealth. So how do we tell if a company we’re invested in can allocate capital effectively?
Companies that make good capital allocation decisions compound value over time. A great example is Warren Buffett’s Berkshire Hathaway.
Berkshire has only paid a dividend once, in 1967. Since then, it has not paid any dividend to its shareholders, and has reinvested its earnings instead.
From 1965 to 2018, Buffett has expertly grown Berkshire’s book value per share by 18.7% annually . Its share price has mirrored that performance, climbing by 20.5% over the same period – compounded, that’s a gain of 2,472,627%.
It is, therefore, evident that a management team’s ability to make good capital allocation decisions is a key factor in compounding shareholder wealth.
But how can we tell whether a management team can make the right decisions to grow shareholder wealth?
A track record of great capital allocation decisions
The most obvious thing to look at is how effective have management’s capital allocation decisions been in the past?
In Warren Buffett case, it’s easy to tell that his decisions have worked out tremendously well. We can judge the overall quality of his decision-making by the growth of Berkshire’s book value per share. But we can also judge his individual investment decisions. One of the key investments that Buffett makes for Berkshire is the purchase of stocks. For this, we can observe the changes in the price of the stocks from when he bought them to today.
But not all capital allocation decisions are so easily measured. Many decisions that a company’s management team makes are based around future earnings and include investments in intangibles which may not be easily calculated.
Measuring success
To me, a good way to measure whether a company has been allocating capital wisely is through its return on equity. If a company has consistently managed to earn high returns on equity, it shows that the capital allocation decisions have been sound.
The return on equity is calculated by dividing a company’s net profit over its shareholders’ equity. Generally speaking, there are two things that we want to see here. First, the return on equity figure should be consistently high. Second, shareholders’ equity should increase over time.
How to measure the success of private acquisitions?
The success of private acquisitions is difficult to quantify. Companies can make acquisitions for a variety of reasons which will not pay off financially for years, sometimes even decades. Just look at Facebook’s purchase of Whatsapp for example. Facebook paid US$21.8 billion for Whatsapp in 2014 and has yet to really monetise the app.
So instead of looking at the direct financial gain, we could judge acquisitions based on a variety of other factors. Here are some questions you can ask when deciding if an acquisition was prudent:
Does the acquisition improve the company’s competitive position?
What reasons were given by management on why the acquisition was made?
Was the acquisition price in line with other deals made recently?
What other financial benefits can the acquirer make from the acquisition?
How was the acquisition funded? If debt was used, how much and would that put the company in a weak financial position?
Investors also need to give an acquisition time to play out. It may be best to only judge whether an acquisition was successful at least two to three years after the acquisition was made.
When should a company pay dividends?
Another critical thing in the evaluation of management’s capital allocation chops is to gauge whether the company is prudently rewarding shareholders through dividends or buybacks.
Not all companies need to reinvest their entire earnings into the business. This may be true if a company has a very mature business and only needs to reinvest a small per cent of its earnings. In such an instance, I prefer to see the company return capital to shareholders either through dividends or share buybacks.
The last thing I want to see is a company hoarding large amounts of cash for no apparent reason. Having a strong balance sheet is very important. But holding too much cash will also be a big drag on the company’s return on equity.
Investors who receive dividends could put the cash to much better use.
Final words
Identifying good capital allocation decisions is important when it comes to our search for companies that can grow shareholder wealth. A company with a great business may still end up squandering its money if its managers are incompetent with capital allocation.
As minority shareholders in public-listed companies, stock market investors need to find companies with managers that they trust can put their capital to good use.
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.
