Archive for

March Update

My troubled feeling about the market began on January 8th.  And not necessarily to the downside. 

I was worried in the sense of “I’m not comfortable with what is going on”.   I was actually worried as much about a melt-up as a melt-down.  I wrote:

I have become actively worried about my hedges. So much so that before the market closed Thursday I went through all my inverse index positions and calculated how much my portfolio would lose from them if the market was up 2%, 3% or 4% on Friday. And then I adjusted their size to make sure each was at a level I could live with.

This is not normal.

I remain uneasy.   About index hedges, about many longs. 

In response, through March I got smaller.  Both on the long side and the short side.  Slowly reducing my hedges.  Reducing my individual longs.   

This week I took the step of being completely out of S&P and Russell inverse ETFs.    I am unhedged! 

Yet I am not bullish.  I added more cash and I reduced a lot of the micro-caps I own.

We have had a crazy period of small cap out-performance.  As I wrote in my last post, I thought that many corners of micro-cap land had gone too far.

So I am changing tact.  Selling the small stocks and looking to own big ones.

The S&P index continues to do great.  If you simply looked at the chart of the S&P, you would conclude I should be very bullish.

That chart is saying that nothing untoward is going on.  The market is clearly going up.  One look at this chart and you would conclude that you certainly do not want to be short right now.

BUT…. under the hood it is far more chaotic – and much less certain.

This is the problem – for me at least.  The market is going up but the same can’t be said for many names.  You can get creamed in this market if you own the wrong stock.

Leading the charge of this malaise are the stocks that led the market up for the last year.  The following two charts are what I would call “type curves” for a wide swath of tech/SaaS, clean energy and biotech high-flyers.

“Type curve” is oil and gas parlance for an expected decline curve from a well.  In a given reservoir you might have 2-3 type curves of potential well performance.  When you drill a well you expect that it will perform roughly along one of those curves, and a bunch of wells should average out to the type curve. 

In this case, our type curves are two charts that fit the form of many, many stocks.

First, the CRSP chart fits all the stocks that ran up huge from the day of the November election until mid-January to mid-February (many, clean energy stocks, biotechs, and lots of micro-caps,).

Second, the TWLO chart fits the SaaS and stay-at-home world.  These are stocks that saw a relentless march up from the March lows of last year until mid-January to mid-February.

For those of you that do not follow individual stocks particularly closely, I recommend going to stockcharts.com and looking up the one-year charts of the following symbols: SE, ROKU, TWLO, PINS, PTON, ETSY, SQ, CRWD, TDOC, NET, TTD, TSLA, Z, PSNL, XONE, SSYS, DDD, FTCH, DDOG, FSLY, ZM, OKTA, TEAM, NLS, ADBE, SHOP, ZS, LSPD, PLTR, HUBS, CDLX, DOCU, IDN, PD, PAYC, CRM, LPSN, EXAS, BNGO, CRSP, PACB, TDOC, NVTA, TXG, CLPT, NSTG.  I could go on.

Tell me these aren’t all the same as one of the above two charts.  The numbers are different, there are nuances, but the type curve, ie. the basic pattern, is the same.

This is just a small sampling – the SaaS names and a few biotechs I follow.  If I listed all the electric vehicle names and clean energy names, like a QS or a FUV, or if I listed all the really crappy micro-caps (like IPWR, OEG, etc) you would see higher peaks and more distinct, severe sell-offs.  But they would all have the same pattern.  The point being that there are so many stocks that fit these type curves right now.

If you spend some time going through all of these charts (and the other 100 or so that I look at each week), it is hard to want to be really long right now. 

These charts all look like they topped out a month or so ago, broke down from that high, and now are about to do one of two things.  Either consolidate at lower but lofty levels, or make their way down another leg.

Is it the former or the latter? I mean, who knows.

But I lean toward the latter.  To reiterate what I said in my last post, there are a lot of names that don’t make sense to me.  To add to that  list, I find it hard to believe that TSLA (to use the most obvious and biggest example) can consolidate at $625, or a $600 billion market cap.  That is 12x bigger than Ford, 10x bigger than GM and 6x bigger than Volkswagen.  Meanwhile its business is seeing competition from all sides, its sales growth slows and its founder appears to be finally getting a microscope to his actions.

Or take PLUG, which even after being cut in half in the last 6 weeks has a market cap of nearly $20 billion.  That is a little less than half the enterprise value of Renault, the French automaker that is partnering with PLUG on a new H2 commercial vehicle.  Renault has $50 billion of revenue and $5 billion of EBITDA.  PLUG has never had $250 million of revenue or even $10 million of EBITDA. PLUG actually had negative revenue last (yes, that’s right, negative) and they are restating their financial statements because they found accounting errors.

But what do I know?  Maybe TSLA IS consolidating at $600 only to make that run to the $3,000 price target that ARK Investments put out for it on Monday this week.  Maybe PLUG IS on its way to being a $100 billion leader of the hydrogen economy.  When things have gone bat-shit crazy there is very little point trying to rationalize what the future outcome may be.

So what am I doing?  Well I am certainly scared to be short and kinda scared to be long.  That does not leave much left.

To a large degree, I am just sitting this out until it is a bit clearer.  I had a good year last year and a good first month and a bit this year and now my main goal is to not blow it.

I don’t like micro-caps in this market for a number of reasons.  First, they had a huge run since November.  Second, the IWM (the micro-cap index) has the same chart as type curve #1.  Third, the IWM is full of names like PLUG and PENN that are high-flyers and could roll over big-time if things go south.

But I don’t own those stocks so what do I care?  The problem is that micro-caps are very susceptible to catching a cold.  If the bigger one’s roll over the smaller one’s will get creamed, even if their fundamentals are far better.

You have to consider which stocks might get caught up in the unwind.  A stock like Intellicheck should be a reopening play, but it is clearly in a downtrend of SaaS and high-flyers and who am I to say that $9 or now $8 is the bottom and not $7 or $6 or $5.  Its basically the same chart as all those stocks I mentioned above. 

And adding new positions in micro-cap land is equally tricky right now.  Take Inspired Entertainment – INSE, a stock I talked about in October (at $3!!). I owned INSE from $3 to $5.50 or so.  I sold it because when a stock nearly doubles in a couple of months, in any normal market it would make sense to take profits.  In this market, I instead watched it go to the moon after I sold.  But if I had panicked (to the upside) and bought the breakout in early March, thinking OMG, FOMO – it’s another leg up (!!!), I would have been creamed this week and last.

That is to say, these are more dangerous times than they appear.  Even though the S&P looks like a smooth train up, there is a lot going on with individual names that raises an eyebrow.  And if you are caught too long (or short for that matter) in the wrong individual name you could get hit pretty hard.  And micro-caps are minefields at the best of times.

On the other hand, I know there are trillions of stimulus checks and I have read or seen so many articles about the Treasury General Account and how there is $4 trillion in it that is coming out and is going to flood everything with liquidity the next few months.  And of course there is vaccines and reopening and blah, blah, blah.  So maybe the indexes keep going higher.

Last post I talked about Facebook and Amazon.  Google is another that has been consolidating for 2 months and does not seem to be particularly expensive for a well-moated tech firm with 20% growth (it trades at 25x 2022 earnings).  Abbvie trades at under 10x earnings and really has not done much of anything.  Likewise for Bristol Myers, which trades at 8.5x this years earnings.  Walgreens is 10x 2022 EPS and is one of the few stocks that has yet to get to its pre-Covid levels.  Even IBM is kinda interesting – 12x EPS and yes I know it is hated but wasn’t Intel hated not long ago?

I am still long many of the regional banks, though with much reduced sizes.  I am out of many of my microcap positions.  My cash levels are high.  I did go long a few gold stocks again, mostly because some of them had become so bombed out a couple weeks ago that they just seemed too cheap (Fiore Gold was down to 3-4x FCF at its low and New Gold is still at ~6x 2022 EPS at far lower copper prices).

Most importantly, I have almost no index shorts.  The only one that remains is a small position on the Nasdaq (PSQ), which I’m keeping on to balance against the mega-cap tech positions.  But I do not trust these index shorts right now.  Take that move Friday afternoon.  That was crazy.

The shorts I have are mostly long-dated out-of-the-money puts on the highest of flyers.  These are smallish bets that have big payouts if I am right and names like TSLA, PLUG, PTON, XONE and the like are not just consolidating and do indeed breakdown. 

I started putting these puts on in January, so some are much closer to their strike prices then they were then.  They only amount to ~1.5% of my portfolio.  If they all go bad then it’s a manageable loss. 

Unlike shorts, with puts I can only lose what I invested.  In that January 8th post I explained how nervous I was with TSLA, that it might gamma-squeeze further and that my short position might blow up one morning.  It may have been irrational but the fear was real.  So I exchanged my shorts for long-dated puts. 

These and other puts I bought are now in the money.  If a few of these high-flyers continue to crumble, they could be worth gains of five or ten times.  I still need more weakness to get those kinds of gains so it may not happen.  I need TSLA below $400 or PLUG below $20.  But we’ll see.

These next few weeks will be interesting.  We’ve have two tests of the support levels.  You can see that with the TWLO and CRSP charts.  Another rally maybe?  And then if that one fails, things won’t look very rosy for the type curve stocks.

Running out of Steam

Programming Note: I deleted my first 20 subscribers by accident. I do not know who I deleted but if someone mentions no longer having access to the blog, please have them contact me.

The good times are gone and it is time for moving on.

Well, at least from the gamma squeezes.

I’ve sold all the names that might have been squeezed. I have gone short a few of the most egregiously priced stocks. And I am long the largest of the large, as I will explain below.

I have not written too much since I talked about the gamma squeeze idea a month ago because really, what is the point? When what is working are stocks you were embarrassed to say you own, who wants to put up research and reasons for that ownership for all posterity to see?

Better to make some short term bets and collect dollars in the shadows, with no one the wiser.

I should not say the good times are gone. I do not really know. There is another round of stimulus checks coming, so it is possible there will be a round two of the silliness. But I really hope not. It is just so dumb.

I am actually starting to find the whole thing a bit annoying. There are so many crazily priced stocks. That these 3D printing names have gone up to such insane levels (though they finally came off thankfully) on growth that is, at least so far, very moderate, is just unfathomable to me. The same can be said for many biotech names. And of course for the EV stocks.

I was happy to see Zoom drop after every twitter shill screamed about its magnificent quarter last night. Not because I have anything against Zoom. But it seemed to signify a lessening of the euphoria in the market.

With that in mind, let’s talk about Kopin. I wrote up Kopin last fall, I wrote about it here, and I held the stock until $3.50 or a little above that. Now the stock is $9 and their quarterly results today were good. They were pretty much inline with what you’d expect given the large military contracts they announced last year that we knew they would be delivering on beginning in Q4.

On these results the stock was up another $2.50 early in the morning. I mean, holy geez. This idea that there is no limit to what something is worth as long as they beat has gone too far. Kopin is up 900% since the last quarter. So after a move like that, just because they beat the outdated analyst estimates… (the average estimate I saw was ~$9.5 million of revenue, which meant that the analysts weren’t really trying. They had clearly not updated their numbers to account for the big contracts that had been signed and so those estimates were basically meaningless). Nevertheless, the stock goes up another 25%? Come on.

When the stock was nearly $12 today Kopin was a $1 billion company. When I was looking at Kopin it was a $130 million company! That was 4 months ago? Its worth $1 billion now? Something completely game-changing must have happened right?

Not that I can see.

The biggest thing that happened is what I just said. Kopin began delivering on a couple of big military contracts. Nothing surprising. We all knew this was coming.

But what about the consumer AR/VR? Yup, no doubt about it, there is a big potential opportunity ahead in consumer AR/VR. That is what I liked about the stock in November. And yes, it maybe appears to be coming to fruition faster than anticipated. Maybe. On the call Chin Chiang Fan (the CEO) said the adoption cycle has been brought in 2-3 years.

But the numbers… I mean I did a DCF on this stock when I bought it. Those results are, quite honestly, why I didn’t hold it to these double digit nosebleed highs. I’ve played around with that model today. If you make what I think are some extremely optimistic assumptions, with many years of 40% growth and 15% FCF margins, and then you give Kopin a decent 15x FCF multiple on the terminal value 10 years from now, you get a price that is about $14. So a little higher than the high today.

Yet Chiang Fan is already explaining the reality. On the call he said gross margins are only going to be 20-30% for consumer wearables. This is not a SaaS business. So yeah, the volumes, when and if they come, will be high, but margins will be lower. I think my FCF assumption of 15% is likely too optimistic. We know one of the stumbling blocks of AR/VR is that the devices are expensive. According to MS “Apple’s flagship iPhone 11 Pro retails for $999. The Oculus Rift costs $599. The HTC Vive costs $799. And the Microsoft Hololens costs $3,000+.” This is all going to eat into hardware supplier margins if costs are going to come down.

Meanwhile there is going to be competition. Kopin is not in the Facebook Oculus product. According to BoA, Facebook is “massively investing” in the space. These small companies can get outspent and marginalized quite easily.

Finally, as Morgan Stanley pointed out in a piece a few weeks ago there is still no killer use case. A few months ago, when I was digging into Kopin, there was a lot of talk around education, virtual tours, medical procedures, and how these “stay-at-home” use cases would be the trigger for wide based adoption. But now, with a vaccine, how likely are these use cases? Are we really going to choose to go house hunting virtually when we could just drive and look at the place. Or attend virtual school? I’m not so sure.

I am not trying to diss on Kopin here. I love Kopin. I did well on it. It probably has a great future. At the right price I would buy it back. But right now the stock is pricing in a world of nothing but growth and roses. And my experience kinda says that does not happen most of the time.

So that is one and I spent a lot of time there talking about it. A couple other shorter takes. These 3D printer companies. Take Stratasys. At the top the stock had quadrupled since November. Things must really be booming right?

Well, not really. They had results Monday. The company forecast flat revenue next quarter and mid-teens growth in the second quarter.

But wait, mid-teens, that sounds good, right? Well yeah, but this is using comps of 2020, when they saw a 28% year over year revenue decline. Before 2020, when revenue was down 18% for the FY, Stratasys had 4 years of essentially flat yoy revenue.

When I look at average estimate for Stratasys, the growth horizon is about 10% growth as far as the eye can see. The company has generated some free cash flow in the past, but it will take a lot more to live up to that $1.8 billion valuation that they have now.

The main acceleration appears to be the share price. I guess we just have to believe. Things will change, the promised land will come, growth and profitability will manifest. Just like it will for all the SPACs.

One more example. Acuity Ads. I owned this stock a year and a bit ago and then kinda lost track of it. It is up a crazy amount this year, I think close to 25x. My bad. Acuity came out with their fourth quarter results today and revenue was down yoy. Down? Acuity blamed it on covid and their hospitality clients. I mean, come on. These guys are supposed to be the next TradeDesk. TradeDesk revenue was up 40% in Q4. So why is it up 25x?

There is not anything wrong with any of these companies. These are actually good companies. But we are in full-on stupidsville here. So many microcaps have gone crazy and it just isn’t a good risk/reward any more. I am not playing that game. Instead, I will look for value somewhere else (and short the insanity where it is most egregious).

With that in mind, this is my one idea right now. A world on its head coming from me:

What if you just bought the big tech stocks. Could even short some smaller one’s if you want to hedge your bet.

Here are my reasons.

For one, Facebook and Amazon have basically not participated in this entire run-up over the last 4 months. Their under-performance has been quite stark. Google has participated because they beat earnings by so much, so maybe you need to wait a bit for that one. Apple might be an alternative, but I did not get a chance to look at it as I did these 3 others.

Second, though I have some chagrin about the overexposure of Mike Green (is he on every podcast these days?) I do believe that his idea about passive investing makes sense. My earlier posts on the reinforcing nature of the S&P carry-trade (here) feed into this as well.

These factors should, over the medium term, mean that these large tech companies, which are pillars of the index, outperform. We have just had a period of crazy out-performance of small-caps. Is it so hard to believe that there could be a mean reversion?

Third, and this is the reason I like the most: these names are actually pretty cheap.

I did simple DCF models of Facebook, Amazon and Google. I followed that up with DCF models of three smaller (but not really small) tech names that I picked somewhat at random: Workday, Atlassian and ZScaler.

In my assumptions I tried to take a very conservative view for the 3 large names. I had growth moderating to the low teens rather quickly and then to 10%, and in Facebook’s case I assumed growth dropped to as low as 5% for the last few years of the 10-year period. With the smaller names I assumed much more robust growth. Workday was the lowest, I assumed their growth did come down to 10% in 10-years. I assumed Atlassian’s growth is well over 20% for each of the next 5 years, followed by a slide to 15% growth thereafter. For Zscaler I make the assumption that it continues to grow at 25% for a full 10 years running.

For all the names I used a 10% discount rate. While I am sure this is wrong, every time I read about WACC and what I should be using I just end up confused, so I decided to go with 10%. And what I really was looking for was an apples to apples comparison.

For each of Facebook, Amazon and Google I assumed a terminal value at 10x discounted FCF at the end of the 10-year period. For the smaller names I assumed 15x.

So the assumptions are all favorable to the smaller SaaS names. Yet even so, they all appear to be overvalued by 20-30%, while Facebook and Amazon are below fair-value, and Google was about 8% above.

And I am not even really trying with the smaller SaaS names. I picked the 3 above mostly because I follow them and like the companies. I’ve owned both Workday and Atlassian in the past. These are all good, free cash flow generating companies.

I am sure with a bit of work you could find much worse.

So in summary: if I were to take longs in these very large-cap names, and take shorts in some smaller tech names as a counter, I would be doing 3 things at once: I would be long passive-momentum, I would be contrarian the current market, and I would be betting on value (at least relatively)!

So I did. This market has, for whatever reason, forgotten about big-tech and decided that micro-caps are worth the moon. Maybe that will change.