Posts from stocks

The Buy And Hold Mindset

When markets are in turmoil, like they have been for most of this year, I like to have a buy-and-hold mindset when it comes to making new investments. It is hard to know when you’ve reached the bottom and can start buying again, but if you think about a ten or twenty-year hold, then it becomes a bit easier.

The Gotham Gal and I buy and build a fair bit of real estate on the side and we generally use a “cap rate” of between 5 and 10 when we acquire and develop real estate. That means we want to generate an annual yield on our total investment (acquisition cost plus construction cost) of between 5% and 10%. If you think of those numbers as price/earnings ratios, then we are paying a PE of between 10 and 20 times earnings.

It is true that PEs and cap rates and most other “investment ratios” are impacted by current interest rates. When rates go up, like they have been for the last year, the value of capital assets goes down. That’s what we have been seeing this year, among other things.

But if you think about holding an asset over a very long time, like a building, then you will likely hold it through a number of different interest rate environments. And so what I like to think about is what a reasonable return is for a very long-term hold. And in real estate, that is between 5% and 10% per year in my view.

Riskier assets, like venture capital investments, would require a much higher return than 5 to 10% a year. At USV, we generally underwrite to at least 10x our investment if the company is successful and drop down to maybe 5x on more mature companies where we have a much better line of sight to an exit. A 10x return over ten years is roughly a 26% annual return compounded. A 5x return over ten years is around 17.5% compounded. So riskier assets command higher expected returns.

But if you are looking at a tech stock that is mature, like Google or Apple or Amazon, or even something a bit less mature like Etsy (where I am Chairman and own a lot of stock), or Shopify, or Airbnb, I believe it is appropriate to think about that investment more like real estate than venture capital.

Let’s look at Google. It is down about 30% in the last year to a market cap of about 1.25 Trillion. It generates about $70bn of net income a year (that’s what it generated in the last year). It generates about $80bn of cash flow from operations. So if you think of Google like a building, it is trading at a cap rate of 6.4% and a PE of about 18x. Google’s business is not quite as resilient as a building, which is a hard business to mess up, but it also could potentially grow its earnings significantly over the next decade or two, which is a bit harder to do with buildings.

Would you rather buy Google at a cap rate of 6.4% or an apartment building in your neighborhood for a 6.4 cap rate. I think it’s a tossup. At least it is to me.

Now let’s look at Airbnb. Airbnb’s stock is down 46% in the last year. It is valued at $62bn. In the quarter that ended in September 2022, it generated $2.9bn of revenue and $1.2bn of EBITDA and Net Income. I am not sure why Net Income and EBITDA are the same. Maybe Airbnb is not paying taxes yet. It could be using up loss carryforwards or something like that. But a fully taxed Airbnb would be generating Net Income of more like $1bn or maybe even a bit less per quarter. On an annual basis, Airbnb is likely to be generating about $5bn of EBITDA and maybe $4bn of net income. Airbnb’s cash flow from operations over the last four quarters is approaching $3.5bn. So if you think of Airbnb like a building, it is trading at a cap rate of 5.6% and a PE of 15.5x.

These ratios and numbers are all “back of the envelope.” What I mean by that is there is a much more rigorous analysis that could be done here. I am just trying to use some real companies as examples of what I am writing about today.

My point is that if you think Airbnb and Google will be around for the next twenty years and their businesses will be stable and/or growing, then the prices at which they trade in the market resemble what a real estate owner might pay for them if they were buildings.

And if you, like a real estate owner, want to own these assets for a long period of time and generate an annual return of between 5% and 10% on them, compounded over ten to twenty years, then today’s prices look pretty reasonable to me.

A 6.4% annual return compounded over ten years is about a double on your investment. A 6.4% investment compounded over twenty years is about 3.5x your money. So if you are saving for a retirement or college expenses or something else, you have a long-term opportunity and so thinking long-term can be very helpful.

To be perfectly clear, I am not recommending Airbnb or Google stock here. I like both companies very much and think they are dominant in their sectors (travel and search) and likely will continue that dominance for the foreseeable future. But all businesses are at risk of poor management, new competitors, changing market structures and technologies, and many other things. Return comes with risks. Buildings can be risky too. Neighborhoods can change. Tax and other laws can change.

What I am saying, however, is that many of the top tech companies have seen their stocks tumble between 30% and 80% in the last year. Shopify is down 75% in the last year. Twilio is down 83%. Cloudflare is down 75%. These are companies I am quite familiar with, know the CEOs, and admire. Again, I am not recommending these stocks. I am just saying that prices have come down a lot in the last year and fundamental analysis, at least on some, suggests they are in the range where a long-term buy and hold could make a lot of sense.

Does that mean the stock market has bottomed? Absolutely not. It may have. It may not have. But if you are investing for a very long time horizon, you may not want to think about trying to time the bottom, which is very hard to do anyway, and just think if investments you make now and hold for a long time make sense. And on that measure, I feel that the answer is starting to be yes.

If markets continue to tumble into next year, then we will have opportunities to buy great companies at even lower PE ratios and higher cap rates. And there is some chance that will be the case.

So another thing I like to think about is taking a long-term approach to making investments. If you decide to invest $100,000 into the stock market because you agree with my reasoning in this post, then it would make a lot more sense to invest $10,000 a month over the next ten months than invest all of the $100,000 this month. The markets may move up on you making the later investments more expensive. But they could also move down on your making the later investments more attractive.

Since we don’t know which way markets will move, it is best not to try to time them and just average into a position over a reasonably long time period.

Markets are not rational in the short run. They become overheated at times and those are excellent times to sell some of your investments and move to cash for a while. They also become overly beaten up at times and those are excellent times to deploy that cash back into the markets. Knowing when you are in which situation is critical and fundamental analysis using cap rates and PE ratios and expected returns can be very helpful in determining that.

#stocks

How This Ends

Back in February of last year, I wrote a blog post with the same title and said this about the asset price bubble we were living in and investing in over the last few years:

The big question is how does this end?

I believe it ends when the Covid 19 pandemic is over and the global economy recovers. Those two things won’t necessarily happen at the same time. There is a wide range of recovery scenarios and nobody really knows how long it will take the global economy to recover from the pandemic.

But at some point, economies will recover, central banks will tighten the money supply, and interest rates will rise. We may see price inflation of consumer goods and labor too, although that is less clear.

When economies recover and interest rates rise, the air will come out of the asset price bubbles that have built up and the go go markets will hit the brakes.

Well now the markets have hit the brakes and the new question is how that ends.

I have been using the early 80s as a bit of a mental model. The late 70s saw oil prices rise and stagflation emerge and while that is not exactly what has happened with COVID and the war in Ukraine, there are some similarities.

In the early 80s, the G7 economies tightened the money supply, raising interest rates dramatically, in an effort to bring inflation under control. You can see the effect in this image:

The early 80s had a double dip recession (one in 1980 and another one for 18 months in 1981 and 1982). The economy was weak for three years at the start of the decade. But the latter half of the decade was one of the best economies in modern times.

So I suspect we are either in a recession right now or headed to one, brought on by tightening money supply/higher rates that are being used to control inflation. That recession could easily last until the end of 2023. But we don’t really know how long it will take for this cycle to play out.

Markets have already corrected and I think that public tech stocks have already seen most of the damage they are going to see. I don’t know if we have hit bottom but I think we are closer to the bottom than the top now. But that does not mean they will turn around and go right back up.

This is a price chart of the NASDAQ during the early 80s recession and you can see that prices did not start to move up until the second half of 1983, when the recession was starting to end.

So how does this market meltdown that we are now in end?

First, we need to see the economy slow down and inflation slow down. We need to see stocks bottom out and hang out there for a while. And we need to be patient. None of this is going to happen fast.

I would be planning to ride this thing out for at least eighteen months or more.

#Current Affairs#economics#entrepreneurship#stocks#VC & Technology

The Selloff

The stock and crypto markets have started off the year in selloff mode, with the Nasdaq down almost 5% this week and the big crypto assets down almost 10% this week. But this selloff has been going on for a lot longer than one week. It has been going on since early November when the Nasdaq peaked at $16k and BTC hit $67k. Since then it’s been downhill and the biggest carnage has been in the highflying “cloud” stocks. The Gotham Gal and I own a few stocks that have been cut in half in the last two months. Yes, they lost half of their value in the last two months.

Of course, these highflying stocks have only given up some of their gains over the last two years. In the case of a few of our public stock holdings, they went up 10x in the last two years and are now “only” up 5x. Easy come, easy go.

Even at these new “discount” prices, none of these stocks look cheap to me. Most are still trading well in excess of 10x revenues which has always been my baseline for a subscription-based software business. I don’t know where they will bottom out, but it certainly could be lower. Or the sector could have already bottomed out in this first week of 2022 blowout sale. One never knows where the bottom is until you are well on your way back up.

The capital markets have been awash in money for the entire pandemic and it has resulted in some crazy prices being paid for public stocks and for growth rounds in high-performing privately held companies. The optimist in me sees this selloff as a return to normalcy, in the capital markets and in the world we live in. It’s hard to see a return to normalcy when offices remain closed, events are being postponed or moving to virtual. But markets tend to see things first and I do wonder if the capital markets are coming back to earth in anticipation of things getting better this year.

It also makes me wonder if the “pay any price” mentality in venture may ease up a bit this year. When the IPO markets or the M&A markets can’t/won’t be able to pay more for a business than the private markets are paying, that’s unsustainable. It can last a few quarters, maybe even a year. It can’t last forever. We will see.

#crypto#stocks#VC & Technology

Meme Investing

I remember when a friend of mine told me five or six years ago that he had bought some Dogecoin. I thought “what is he doing?” and dismissed it as something silly and or crazy.

Dogecoin was initially introduced in late 2013 and 7 1/2 years later it has amassed a market cap of $43bn and is one of the most popular crypto assets in the world. It may be silly and crazy, but it has also been a good investment for my friend and anyone who bought it in the early years.

For those that don’t know, Doge is an internet meme that became popular around that same time. The combination of memes and investing is a powerful cocktail that I have been ignoring for a long time, probably incorrectly.

More recently we have seen meme investing move into public market stocks like Gamestop, AMC Theaters, Wendy’s, and more. The community that drives these “meme stocks” is based in Reddit and the combined purchasing power of this community is substantial, particularly in illquid stocks (and crypto assets).

It is easy to dismiss meme investing. The market capitalizations that these meme assets trade at make no sense on any fundamental analysis. But, as I’ve come to understand, that is not the point.

Memes are fun and memes are also something to come together around. Speculating on the popularity of memes and their staying power is no different than any other form of speculation.

But more than that, and this is where my head has been going on this topic, the market caps of these memes are also economically powerful. If the board and management teams of the companies with meme stocks choose to issue more shares at these prices, they can raise a lot of capital to transform these companies. Similar opportunities could exist with meme tokens. AMC recently did this with their “meme stock.”

I’ve decided that I am going to stop ignoring and dismissing meme investing and start trying to understand it better. I think it is not something that is going away anytime soon and may turn into something even more interesting.

That said, I am not suggesting that anyone invest their retirement money or their savings for their kids’ eduction into memes. I believe it is more appropriate for speculating right now. That may change. Or it may not. That is yet to be determined.

#crypto#stocks

The Light At The End Of The Tunnel

In my Jan 1st post talking about what I expected to happen this year, I wrote:

I think we will see the end of the Covid Pandemic in the US sometime in the second quarter. I believe the US will work out the challenges we are having getting out of the gate and will be vaccinating at least 40mm people a month in the US in the first quarter. When you add that to the 90mm people in the US that the CDC believes have already been infected, we will have well over 200mm people in the US who have some protection from the virus by the end of March.

Seven weeks later, it seems like that is pretty much what is playing out. I have read that about half of the population of the US now has some protection against the Covid 19 virus, either via having had the disease or by being vaccinated at least once. At the current vaccination rate of 1.8mm a day, the number of people who have at least some protection against the Covid 19 virus will be about 70% by the end of March.

What that means is the virus will spread less, infecting less people, and less folks in the hospital or worse. I believe that means a gradual re-opening of the economy throughout much of the US in the second quarter with schools, stores, restaurants, and nightlife coming back. I am sure that precautions will continue for much, if not all, of 2021 because nobody wants to take this lightly after what we have all been through.

If that is in fact the case, and we don’t know for sure that it is, what does that mean for the economy, businesses, tech, and more?

I wish I knew. But I have some suspicions.

As I have written here quite a few times, I believe that habits that we have formed in the last twelve months will stick with us even when we don’t need to use them anymore. I believe work from home has proven to be very effective for some, possibly even a majority, of knowledge workers. E-commerce has delivered (no pun intended) and the gains it has made against in-store retail will not be given back much, if at all. Remote learning is here to stay. So is telehealth.

I also believe that the things we have not been able to do in the last year; travel, be tourists, see live music, live theater, live sports, and all of that will be in more demand than ever. As Joni Mitchell said, “you don’t know what you got until it is gone.” We want all of that back and I think we will embrace being with others experiencing things in the real world with a passion.

But where all of this lands is anyone’s guess. And there are many businesses whose near-term fortunes depend on how the balance of remote vs in-person lands over the rest of 2021.

I also think a re-opening may not be great for the stock market, which was a major beneficiary of the pandemic. The NASDAQ is basically up 100% since March 20, 2020. I wrote a bit about why I think that might be the case last week. I don’t know how quickly a re-opening will impact the stock market, but I do think it could.

But let’s not get negative here. And end to the Covid pandemic and a re-opening of the economy would be about the best thing that could happen to the US and the world and I am becoming more and more optimistic that it will start happening in the second quarter of 2021.

#Current Affairs#economics#employment#stocks

The Revenge Of Retail

A number of people have been asking me what I think of the Game Stop situation. This is not really my world. I don’t trade stocks, we hold them. I don’t use Robinhood, though I have an account thanks to my friend Howard. I don’t hang out on Reddit, though I visit it from time to time.

So I have not paid enough attention to this one, but it certainly is fascinating. The generational aspect of this is important. Boomer hedgies getting crushed by young folks self-organizing in social media. It feels like a moment where you realize that the power structure has shifted and things won’t be the same.

The financial system in the US, and in other developed countries, is a rigged system and has been for a very long time. Only big institutions can get into hot IPOs. Only rich people can invest in startups. Many of these rules are designed to protect “widows and orphans” but all they really do is make the rich richer and keep those without money out of the game.

Not anymore. Whether it is crypto (Coinbase) or day trading (Robinhood), the retail investor now has the tools to get into the game and win the game.

The new startup investing is buying into the Ethereum crowdsale. Had you done that in the summer of 2014, you would be looking at roughly 1,000 times your money right now. And that crowdsale was launched by a team led by a 20 year old. Though the SEC and others would like to impose the same rules on crypto that protect the rich and keep out everyone else, that has not happened and I pray that it won’t.

The new hedge fund is the Robinhood army self organizing on Reddit. They can move a stock more easily than the largest hedge fund.

There will be calls to regulate this “madness.” But it is the same madness we have always had. It is just a different crowd in charge.

I do worry that this Game Stop short squeeze will end badly and not only the hedge funds will get hurt. Markets can be brutal. But regulating markets to protect the small investor is not the answer. As we can see, the small investor is often a lot smarter than the large investor.

What we need to do is stop printing money to stabilize the economy. And start addressing the real economic issues that exist on main street, not wall street. Monetary policy is not the answer. Fiscal policy is. That won’t stop more Game Stops from happening. They are a by-product of markets. But it will get the money to where it is needed versus where it is just gameplay.

#crypto#Current Affairs#economics#stocks

Innovation In Capital Markets

A few years ago, maybe in 2016, we held a discussion of blockchain and crypto technologies at the annual meeting of our limited partners. I recall someone in the audience suggesting that the NYSE and Nasdaq could rebuild their markets on top of these technologies. I replied that I thought it was more likely that new markets built on blockchains and existing for crypto assets would emerge to compete with them.

And here we are, with a 24×7 global marketplace for crypto assets that has a market capitalization of over half a trillion and daily volumes in the hundreds of billions. This pales in comparison to the legacy capital markets, but that is always the case with a new entrant on the scene.

The legacy capital markets are not sitting still. There is real innovation happening in the IPO process for example.

But if you want to see the world we are headed into, I think it is better to look at the crypto markets. They operate day and night, they are global, and anyone can buy, sell, hold, and send these assets as long as they have a crypto wallet and a browser or a phone. You don’t have to be wealthy to invest in crypto startups. Anyone can do it.

The crypto markets are also innovating in areas like lockups, vesting, and governance. In a traditional IPO, the existing shareholders are typically locked up for 180 days and then the lockups come off entirely. In the crypto markets, we see all sorts of different forms of vesting and lockups being tried. What is emerging are lockups for existing holders that are much longer, but with small amounts of early and regular liquidity.

We are also seeing a lot of innovation around governance, with crypto projects working on ways to allow the community of token holders to have real say in the way a crypto project operates. We have seen a number of communities make very significant changes in things like total supply of tokens, inflation rates, and technology roadmaps in recent months. I cannot think of a public company that allows its shareholders that level of impact on their direction.

Right now these markets are operating as parallel universes, but I don’t think that will be the case forever. It is fairly simple to tokenize equity securities and trade the tokenized version in the crypto markets. That is not really happening just yet, but I expect that it will in the not too distant future. Then we will have the opportunity to see two identical assets trade in the traditional and emerging markets. There will be arbitrage opportunities and more when this happens and the new markets will put pressure on the traditional markets to adapt and change and evolve as fast as they can. That will be hard, if not impossible.

The global nature of the crypto markets is also a challenge for regulators, who have stood in the way of innovation and continue to do so. Why, for example, does one have to be wealthy to invest in startups in the US? That’s simply a way to keep the wealthy rich and everyone else not rich. If you trade crypto assets and something is not available in the US, you can trade or lend or stake elsewhere. And many/most do that. This allows innovation to happen in crypto even when some jurisdictions, like the US, are slow to embrace and hostile toward innovation in capital markets.

So if you want to see the future of capital markets look here, not there. That’s where all of the innovation, experimentation, and new stuff is happening.

#blockchain#crypto#hacking finance#stocks

Knowing What You Are Looking For

There are many ways to invest successfully. Public stocks, bonds, private equity, real estate, venture capital, etc. And within each category, there are so many different investment opportunities.

In public stocks, there are something like 5,000 listed stocks in the US. In venture capital, there were something like 30,000 companies that raised venture capital in 2019.

How do you make sense out of all of that opportunity?

I’ve always been a fan of knowing what you are looking for and ignoring everything else. We call that thesis based investing at USV, but it is actually more than that.

We can say that we are looking to back trusted brands that increase access to capital, wellness, and knowledge, and we do. But we do more than that. In each of those sectors, we go deeper and identify specific areas within them that we want to target. We call those “deep dives.” We identify areas we want to focus on and areas we don’t want to focus on.

All of this is a relentless effort to figure out what we are looking for and then go out and find it. It is not a static thing. It is a dynamic thing. A pandemic comes along and rocks our world. Time to revisit the thesis and the deep dives. When the pandemic ends, and it will, we will factor that into our thinking too.

In a world with so much opportunity, it pays to ignore the vast majority of it and focus on a tiny bit of it. That may seem counterintuitive, but I am certain that it is the right thing to do.

#stocks#VC & Technology

The Covid Rotation

Yesterday morning we got the news that Pfizer’s mRNA Covid vaccine developed in partnership with BioNTech saw 90% efficacy in phase three clinical trials. While this is terrific news, Wall Street saw it as bad news for companies that are doing well during this pandemic (Zoom, Peloton, e-commerce, etc).

This is a chart of Jim Cramer’s Covid 100 index:

Wall Street believes the end of the Covid pandemic is in sight and is rotating out of this group. I see that as terrific news, even though I am a large holder of a name or two in that index.

I cannot wait until I can start meeting entrepreneurs again in person. I cannot wait until USV can meet together in person. I cannot wait until I can see live music, movies, theater, etc, etc. These things cannot come soon enough for me.

But I also wonder how many of the habits we acquired during this pandemic (which is NOT over yet), will stick when we can go back to doing all of these things we long to do.

Here are some questions to ponder:

1/ Will our use of Zoom to meet decline materially when the pandemic is over?

2/ Will we get back on planes and resume our business travel like we did before the pandemic?

3/ Will we go back to the spin studio even though we learned to love a spin class on our Peloton?

4/ Will we rush back to stores and abandon our e-commerce habits?

5/ Will we all go back to the office five days a week?

I think the answer is yes to a degree, but almost certainly not totally. We have created new habits in this awful year and they are not going to go away so quickly, or ever.

I don’t know if that means the Covid 100 index is a buying opportunity or it needs to go down some more. I will leave that to Jim Cramer.

I do know that the way we work and live and entertain ourselves has changed materially and forever in this pandemic and things won’t be exactly the same when it is over.

#Current Affairs#stocks