I though the new pitch from Joel Litman at Altimetry was kind of interesting, and it sure teased a bunch of ideas, so we’ll run through that one today. The newsletter being touted is Hidden Alpha ($49 first year, renews at $199), and it’s part of the Altimetry group that’s a joint venture between Litman’s Valens Research organization and Stansberry Research (now part of Beacon Street, which has agreed to go public through the ACND SPAC).
The general pitch from Litman over the years has been that accounting is broken, that GAAP accounting creates a “garbage in, garbage out” situation for investors, where valuation arguments are based on faulty data, so his newsletters and his research organization focus on identifying places where their uniform accounting would highlight a stock that’s a better value than GAAP accounting implies — they describe this as being a “stock cop” in the latest ad, “policing” portfolios for stocks where the as-reported accounting would send you astray.
Litman and Valens/Altimetry sell several different research products, and access to their databases of adjusted financial results, but this particular offering is sort of the “entry level highlights” version — they find a universe of companies where differences between their “uniform accounting” and GAAP accounting create a real discrepancy, and then also do what they call “forensic analysis” of the earnings calls to help identify when company management is either unusually evasive or unusually excited about the future, and pick the best stocks using that info. They say this Hidden Alpha service focuses on relatively safer large-cap stocks (High Alpha, which is the “upgrade” newsletter in this particular marketing funnel, at about $5,000 a year, focuses on small caps).
So… what’s he pitching now? The lead-in is about how the vaccine progress clobbered some of the big pandemic “winner” stocks…
“The market lost a third of its value when Covid hit…
“But I believe the vaccine’s effect on the market could be even worse than the virus itself.
“This ‘stay-at-home’ sector could see losses of 75% or more after the vaccine takes hold.
“As Americans lives go back to normal, many of these ‘stay-at-home’ stocks will be exposed as short-term fads…”
He puts stocks like Zoom Video (ZM) into that category, but that’s not what’s interesting here — he also hints at some other ideas that will continue to be profitable.
“The chance to position your portfolio correctly – ahead of time – is an opportunity you may never get again.
“Because not everything will go back to normal once Covid-19 has gone away.
“Some of the changes we made during the pandemic will stick.
“In the last year, we’ve undergone a massive shift in habits.”
And he repeatedly touts something he calls his “L.O.C.K. System”, which is described as: Looking for stocks that have outlier financials, with big discrepancies between “real” and “as reported” financials; Checking out the Operations of those companies to qualitatively assess the potential, the managers, the industry, their long-term strategy; Analyzing their conference Calls for those CEO voice patterns that indicate stress, deception or optimism; and then making a decision (that’s K, for “keep it or kick it”).
Doesn’t sound terribly different than any other assessment you might make of a stock, though I guess it standardizes the things that a lot of experienced investors do almost by habit — the quantitative adjustments to large numbers of stocks through uniform accounting is different than the one-stock-at-a-time decisions about places where the SEC filings are hiding a story that’s better than it appears, and the computerized screening of the conference calls is perhaps a better high-volume solution than listening to the calls yourself and making your own qualitative assessment of management.
Here’s a bit from the ad to get us back on track:
“When I ran these stay-at-home companies through L.O.C.K., I found a common thread that separated the winners from the losers.
“The key to understanding which companies will thrive in the post-vaccine world – and which won’t – is simple.
“If the new habit was an improvement over the old, it will stay…
“If it was just a temporary fix, it won’t.”
That I agree with — some stuff will clearly drift back to the way it was, some of the better tools we adopted during COVID will stay adopted. I’ve noted this a few times in the case of Chewy (CHWY), for example — once you’ve gotten your pet food delivered on a set schedule every month, never running out and never having to lug a 40-pound bag of dog food to your car, you don’t go back to the old way. Bringing new people into e-commerce was a one-time shift, but a lot of those people will stay shifted for a lot of their purchasing, whether it’s dog food or groceries or a thousand different things from Amazon.
Litman goes on…
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“But there are three habits that have proved overwhelmingly convenient during the pandemic.
“These options are far superior to how we did it before Covid-19.
“And there’s barely any extra cost to the consumer for the convenience.
“All evidence suggests the genie can’t be put back in the bottle.”
And, as you might imagine, e-commerce is one of those “habits” — here’s his first bit of teasing:
“ENDURING HABIT #1: We Will Never Shop The Same Way Again…
“Americans are shopping online at an exponentially higher rate than before the pandemic.
“In fact, 3 out of 4 people tried shopping online for the first time in 2020…
“Half of all those people said they would continue to buy groceries online, even after the pandemic….
“As more consumers went online, companies spent more to bolster their online shopping systems.
“Eventually, this network acceleration becomes a permanent change.”
He goes off on an aside about what a terrible business food delivery is, particularly singling out DoorDash (DASH) as a company that can’t make money, but then goes on to get us thinking about the safer winners…
“Rather than try to pick winners in a highly competitive business – why not invest in all of them at once?
“And the way to do that is by investing in companies who power the infrastructure of the online shopping industry.”
The first one has something to do with payments…
“How does money get from one place to the other online?
“Extremely complicated remote payment programs.
“And this company’s proprietary technology is at the heart of the remote payment business.
“They’ve been around almost as long as the internet.
“On average, their software handles 41.5 million transactions every single day.
“That amounts to over $20 billion in remote payments every week.
“8 in 10 online buyers use their technology – even if they don’t know it.”
OK, so it’s one of the companies in the payment processing business. Any other hints about it?
“Right now, this payment processing giant is flying under the radar.
“But the L.O.C.K. system says the company has the same potential for growth as Square.
“You could have gotten in back in 2016 and watched as it went up as much as 816%.
“Could this new recommendation go even higher?”
That $20 billion/week number narrows things down a bit — as, of course, does the “8 in ten” number. That means we’re dealing with one of the very large and established companies in the payments business. Which one? There are two that come close to matching and seem pretty interesting at this point, Adyen (ADYEY, ADYYF) and Global Payments (GPN).
Adyen in the last quarter did about $16 billion in transaction volume a week, so that’s in the neighborhood (it’s not really a precise clue, so we shouldn’t be too exact… but it should be close), and it wasn’t founded until 2006. It has been the fastest-growing big payment platform for a long time, thanks to its digital-first design that has it providing services for new giants like Netflix, but it hasn’t been around all that long.
The back-of-the-napkin numbers for Adyen are a market cap of $69 billion, trailing sales of $4.2 billion (price/sales about 16), 40% revenue growth (which is crazy high, but a deceleration from last year’s 52%), 25% ROE and 7% profit margin. They had some weakness in mid-2020 as their POS volume was a little low (since physical stores were closed) and sales from travel-related businesses fell, but bounced back strong by the end of the year with e-commerce growing so fast — and only about 10-15% of their payment volume is on-premise POS terminals, so e-commerce is the heart of the business. In-store retail in December was just about back to where it was in January of 2020, but total volume was much higher because of the surge in e-commerce sales all year and strong e-commerce sales during the last couple months of the year. They expect to grow their net revenue by at least 25-30% a year, with pretty low CAPEX and gradually improving margins.
Global Payments (GPN) is the other pretty appealing contender for this teaser match, and is pretty similar to Adyen in some ways… but has been around much longer. It has its roots in National Data Corporation, and was processing credit card payments by the late 1960s and had pretty dominant market share in that business by the late 1970s. That card processing arm of NDC spun off as Global Payments in 2000 and started trading separately in NY in 2001, and they’ve been building and buying card processing technologies and networks ever since. They merged with TSYS in 2019, which jolted their revenue meaningfully higher, though their earnings per share have been on a downswing for a few years. GPN has had some pretty massive depreciation numbers for the past couple years, maybe that’s associated with their acquisitions/mergers, I don’t know.
GPN’s numbers, for comparison to Adyen (they’re not exactly the same kinds of businesses, but similar), are a market cap of $60 billion, trailing sales of $7.4 billion (price to sales of about 8), revenue pretty flat over the past year thanks to COVID but expected to bounce back, 2% ROE and 9% profit margin. They announced some large share buybacks ($1.5 billion authorized) and a new collaboration with Google to expand their merchant business. They expect to have 11-13% revenue growth in 2021, and earnings of at least $7.75 per share (21% growth). They’re trading at about 22X forecasted 2022 earnings right now, with earnings growth expected to be close to 15% a year, and they pay a paltry dividend (about 0.4%).
Because of the general focus of Altimetry on finding earnings strength that is obscured by accounting rules, and the big depreciation charges at Global Payments, I would guess that GPN is a better match for Litman’s tease, and that assessment is made easier by this glowing article Litman posted about GPN back in October, though with those clues I can’t be 100% certain.
I’d personally lean slightly toward Adyen, given their much stronger revenue growth and very strong relationships with major online players, including their work with Microsoft, but GPN is no slouch, they’re going after that business too, and they trade at a more appealing valuation.
Other candidates might be large players like Fidelity National Information Services (FIS) or Fiserv (FISV), which are not as close to being pure plays on payment processing as Global Payments is, but do trade at similar valuations. None of these have nearly the growth potential that Square did five years ago, but that’s because Square was a very small company then — these are all $60-100 billion companies, Square in 2016 was a $3 billion company (though to be fair, it was already fairly substantial — the recognition of the value of payment networks has been dramatic in the past couple years, Square had a billion in revenue and traded at 3X sales back in 2016, now it has $10 billion in revenue and trades at 10X sales).
What’s next? The “Giants of Online Shopping” part of his tease is a two-parter…
“Right now, this second company is a one-stop shop for cloud computing, AI and data storage.
“Making it massively important to the online shopping universe.
“Apple pays them $30 million a month to run its massive cloud.
“Netflix paid $19 million a month during the pandemic to keep its streaming service up and running.
“Facebook forks over $11 million every month…
“Over 100,000 companies as diverse as ESPN, Pfizer, Zillow and McDonald’s would shut down without the company’s cloud services.”
That’s kind of an easy no-brainer, I’m afraid, so we’re going with the large-cap to beat all large caps — those hints all point at Amazon (AMZN) and its powerful and market-leading Amazon Web Services, which was indeed reportedly getting $30 million a month from Apple and $19 million a month from Netflix in recent years. I wrote in some detail about Amazon when Jeff Brown pitched them as the key to “6G” as the most powerful tech company in the world.
What’s left to say about Amazon? It felt expensive when I first bought shares four years ago, but I’ve also kept buying from time to time. Here’s how I summed up my opinion when I covered them in my Annual Review back in February:
I’ve changed my thinking considerably about Amazon over the years, so it may be that I’ve dipped too far into “fan boy” territory, I used to worry what would happen if we ever started to value Amazon based on earnings, like a “regular” company… but with the almost unstoppable flywheel of growth they have in both e-commerce and Amazon Web Services, I have gotten very comfortable with trying to be opportunistic, buying on dips and paying anything in the range of 3-4X revenues for this amazing company. We thought it was too big to grow at $100 billion, at $500 billion, at a trillion dollars… maybe it’s time to accept that there’s no artificial ceiling — heck, their sales haven’t even caught up with Walmart yet.
If you use analyst estimates for this year, which I think are too low, the highest reasonably comfortable buy price at 4X sales would be about $3,750… the easier buy is at 3X sales, roughly $2,820. We’re right in the middle of that range now, so if you buy just one tech stock it’s hard to argue that it should be anything but Amazon.
That’s not terribly fun, of course, as individual investors we’d like to pick smaller stocks and buy the things the giants can’t buy, and feel smart when we win… but it’s tough to beat Amazon.
And the next few stocks he hints at are tied somehow to “work from home” …
“ENDURING HABIT #2: We Will Never Work the Same Way Again
“8 out of 10 CEOs said they would allow some level of work from home, even after the pandemic.
“One consulting firm, Global Workplace Analytics, believes 6 times more Americans will work from home at the end of 2021 than before the pandemic.
“So which companies benefit?
“Just like with the first habit, you need to look past the fad stocks.
“And look deeper at the companies critical to the entire infrastructure.
“Without remote payment technology, online shopping wouldn’t exist.
“And without reliable, cheap high-speed internet – working from home wouldn’t exist.
“Our reliance on high-speed internet has increased exponentially.”
OK, so what are they? He calls these the “3 Pillars of the Internet” …
“Each of these companies could make you a fortune.
“But all three of them together could make your portfolio bulletproof.
“Just take a look at the highlights:
“A company who rakes in $38 billion a quarter from its multiple businesses. Its hands are in every aspect of the future of the internet, from cloud computing to Internet of Things, online video streaming and digital advertising.
“Most importantly, they offer businesses a full suite of services – think Microsoft, Zoom and Slack all rolled into one.”
OK, so staying with the mega-cap theme, that must be Alphabet (GOOG, GOOGL). $38 billion was what they hit in the second quarter last year, and that was their lowest revenue quarter in the last couple years. Alphabet is not terribly competitive with Microsoft when it comes to foundational office software, but certainly their suite of tools is a lot cheaper than Microsoft Office, and has gained some traction, and they have tools to compete with Zoom, Slack and pretty much everyone else you might think of when it comes to collaborative work… as well as taking the mantle from Apple in the education market in recent years with their low-cost Chromebook computers and dominant Google Classroom platform, to say nothing of the global dominance of YouTube for video sharing, and those businesses all pale in comparison to Google’s overwhelmingly dominant search and search advertising businesses.
You can daydream about a better match, I suppose, but that’s a high number for sales — there are fewer than 50 publicly traded companies that have revenue of over $150 billion a year, and you’ll recognize almost all of them. I’ve owned Alphabet/Google for 16 years now, and though the last time I bought more was at the March collapse last year, it’s pretty easy to argue that it’s in a reasonable buy range still… here’s part of what I noted in my last Annual Review summary on that one, in early February:
Google is still an extraordinary profit generator, and continues to have a massive cash hoard — they’ve done quite a few stock buybacks over the years, but that really only just helps to slow the dilution from employee stock grants and options so it doesn’t mean much, just a way to capitalize payroll instead of expensing it. There isn’t anything in tech-world that’s objectively cheap right now, so I won’t try to convince you that GOOG is a value stock… but they grew earnings by 14% in the pandemic year despite some major cuts to ad budgets in the second and third quarters, and they are expected to grow earnings to $90 a share in 2023, which would be only a 15% compound growth rate. I think it’s absolutely reasonable to put a PEG ratio of 2.0 on a dominant utility like Alphabet, even with the political and regulatory risks they might face (and as an aside, if the antitrust case leads to a breakup of Alphabet in a few years it would likely create value for shareholders, not destroy it). Going by that anticipated growth rate, which would be reasonably conservative and represent considerably slower growth than Alphabet has enjoyed over the past three years (in which the earnings have grown at a compound rate of more like 35%), I’m very comfortable with Alphabet being a good value at 30X forward earnings, which as of today’s estimates would be $2,015.
That number would be up to $2,075 at this point, if you’re keeping track, since estimates have now risen to over $69 for 2021 earnings. We’ll see how it goes.
And a second “work from home” play…
“This cloud storage company proved so popular with at-home workers that 1 in 5 used this service – even when it was banned by most corporate IT departments. L.O.C.K. sees huge upside in the future hybrid work environment as workers use its products at home and in the office.”
That’s very likely to be Dropbox (DBX), which in some ways is a relative bargain in the “cloud” space — they offer file storage and transfer in the cloud, and it has indeed been widely reported that employees use Dropbox even when they’re not supposed to. The Altimetry/Valens Research folks have posted in the past about Dropbox, noting that the “uniform ROA” is actually much higher than their reported earnings — that’s largely because of high R&D spending that is driving higher revenue but is expensed (part of the argument from Altimetry, as I understand it, is that for many companies R&D should be considered more like a capital investment than an operating expense).
I do have some call options on Dropbox still, though do not follow them very closely and haven’t written about them much — the biggest risk is probably competition, since file sharing and storage is a fairly simple operation, but they do have a strong and growing business, with pretty loyal customers who are using the service even though their employers tell them not to… so clearly they’re providing something meaningfully better than competitors like Box (BOX, about a third DBX’s size but also growing more slowly) or, indeed, the file storage offerings of giants like Google and Microsoft.
“The largest internet service provider in America with 26 million subscribers has huge room for growth throughout the country thanks to its proprietary high-speed internet technology.”
That could really be either Comcast (CMCSA) or Charter Communications (CHTR), the two largest cable internet providers in the US (they also happen to provide cable TV services, which used to be their primary business). Each has something in the neighborhood of 25-30 million high-speed internet subscribers, though I believe Comcast remains a little bit larger (and it’s credited with that larger network, they have an enterprise value of about $350 billion, versus $227 billion for Charter). Joel Litman did post a note about Charter’s earnings being distorted by GAAP accounting last summer, noting that the “Uniform PE” was closer to 24X earnings than the reported 50X or so, due to interest and amortization charges. Some of that same “distortion” would apply to Comcast, and he posted some similar notes to that effect about a year ago, though it hasn’t been as recently acquisitive in the cable market as Charter/Spectrum.
And here’s a PSA for one of the “work from home” stocks that Litman thinks should be avoided…
“But there’s one popular work-from-home stock I think everyone should avoid right now.
“You’ve likely used it. And there’s a strong chance you own the stock.
“I’m talking about Zoom Communications…
“My research shows the market is currently pricing Zoom to double in size every year for the next five years…
“And after the vaccine takes hold, we can expect video conferencing to decrease, taking market share away from everyone.
“If you own it, sell Zoom now…
“And take your winnings before the company sinks to the bottom when the pandemic is over.”
And I noted above that DoorDash also gets the “sell” treatment from Litman, and he also teases a list of “rotten” stocks to sell that includes several others — he mentions UPS (UPS), FedEx (FDX) and Domino’s (DPZ) as other sells, though he doesn’t give us any hints about the other nine “rotten” stocks he would recommend dropping.
There are some other teases in this pitch, revolving around the third “enduring habit,” which has to to with movies and entertainment… but I’m out of time for today and we’ve already given you plenty to chew on, so I’ll leave it there for now — if there’s a lot of interest we can move on to see if the Thinkolator can name those movie and video game names in a future piece. Thanks for reading!