As the title of this quarter’s note references the pace of movement within the high-growth areas of the market have been exceedingly quick over the past year. As we’ve also referenced before, the high-growth areas of the market saw their recent peaks well before the broad market indices as high growth companies – specifically referencing the ARK Innovation index – peaked in February 2021 while broad markets hit their highs early in 2022 (S&P 500 & Dow Jones Industrial Average). What most investors understand is that prices have gone down to fairly extreme degrees in these companies, but I think what has been lost is how much has changed under the surface at the company level. Appreciating the detail, I believe provides some optimism for the quarters to come.
Liquidity & Profitability:
For much of the past 5 years and certainly in 2019, 20, and early 21, high growth firms have been the darlings of the financial markets, and Venture Capitalists and IPO Bankers alike have pushed narratives about growth being far, far more important than profits. Private and public companies had more than ample access to new investor dollars and the only thing asked by most in the markets was “If I give you more money can you grow even quicker?”
Well, as luck would have it too much of a good thing can in fact lead to poorly aligned incentives, some complacency within companies, and one heck of a hangover. We’ve always liked profits, however within this portfolio been willing to compromise on current profitability when we believed the company could flip the switch to profit when they needed to and that the dollars reinvested into the business would be far more useful than returned to shareholders via dividends or buybacks. Amazon for example has never paid a dividend and only recently began buying back stock. Decades with all cash reinvested into the business.
Like a snowball rolling downhill that gradually gains speed and mass, last year growth stocks weathered volatility fairly well, but in 2022 the winds of change reached gale-force and the snowball became an avalanche across the capital markets; powered in large part due to Inflation and Interest Rates seeing one of their largest increases in multiple decades. The message was clear from everything beginning with the Venture Capital’s YCombinator offering the warning that “your chances of success are extremely low even if your company is doing well” to the IPO market collapsing from 753 Nasdaq IPO’s in 2021 to just 108 in the first six months of 2022. Even very interesting companies with compelling products like grill company Traeger or electric car company Rivian have seen collapsing valuations. The markets now demand companies to prove profits now.
Again calling back to the title of this quarters note, what we largely anticipated would be perhaps a 5, 10, or 20 year process of many of the innovative companies of today gradually shifting from hyper growth focus to that of profitability has instead morphed into a sort of 20 month crash course in the Kübler-Ross 5 stages of grief. In mid-2021 as growth liquidity largely began to shift modestly downward, executives across the world were largely in denial that things might not continue to be the same way they had been.
By the first quarter this year, CEO’s were largely bargaining with Wall Street, trying to figure exactly what the capital markets were looking for. Over the past 90 days, I’ve been growing in my conviction that we’ve mostly crashed through depression and into acceptance. Provided below are a few examples across the growth landscape from some firms we own and others we’ve avoided that have accepted the world for the way it is today: Growth is desired, but businesses need to make money today.
Uber pivots to profit focus in note to employees
Private Fintech darling Klarna raises money down 85%
Shopify CEO laysoff 10% of workforce, to remove roles too removed from building products
Docusign CEO resigns after poor company execution
Where do we go from here:
After providing this review of the “20 years in 20 months” for Growth Stocks, let me spend a few sentences (okay, maybe paragraphs) offering some thoughts on the future.
As referenced above growth stocks have led, both on the way up and down, over the past 2-3 years. Notably, the highest growth cohort (again using the ARK Innovation Index from earlier) did not break to new lows in the month of June like their large cap and value siblings in the Nasdaq 100 index or the S&P 500. This process of “higher lows” is constructive as despite the headlines of slowing growth, stubborn inflation, and layoffs at some growth firms, markets had moved so harshly early this year that many stocks have actually rallied over the past 6-8 weeks. Bottoming is a process but this is what we want to see.
Doing service to an old Wall Street adage that “Price drives Sentiment”, my best guess is growth stocks will begin to perform well when nobody could be convinced to buy them. We may not be too far from this point today. A Federal Reserve “pivot” to stable rates may also be required for stabilized growth, but we are beginning to see the signs of “disinflation” that tell us this is possible in the next few months (Home price cuts, falling gas prices etc..)
The other point investors need to consider, and we are as we allocate the portfolio, is that companies don’t just stop as markets fall. As referenced above, companies are getting leaner, more productive, and refocused on what made them successful in the beginning. To us, this means it is likely that coming out of this period the growth created through this turmoil has the potential to provide investors with increasing returns through new business ideas. As the saying goes, necessity is the lifeblood of innovation. We don’t expect all our portfolio companies to succeed and dispersion will be wide, but winning enterprises should continue to grow.
Finally, we’re seeing positive news for an important component of growth: semiconductors.
The US Congress is currently considering passage of the CHIPS or CHIPS + Act which would provide upwards of $50 Billion in subsidies and tax breaks to re-shore to America the Semiconductor industry and supply chain (from Asia & specifically China). Semiconductors are vital to many of our portfolio companies as they are an integral part of everything from automobiles to data centers (cloud computing) to Artificial Intelligence. While this letters goal isn’t to pick the winners and losers across the fabricators to the chip designers and equipment companies, all of which have interesting companies to look at, the important note here is that growth in these markets will continue; providing the foundation that many of our portfolio companies build upon. Matthew Albritton, who is working with our team as an intern this summer before he heads back to UF to finish undergrad, has been very helpful to our investment committee in dissecting this bill and helping inform investment considerations as a result.
There are no doubts that growth stocks have thrown a lot the way of investors this year, but we remain focused on our task of identifying and allocating to the companies that we feel have strong business models and innovative market leading products. We have some cash in our portfolio to put to work this this fall and we will pick our spots to do so keeping in mind the long-term process we wish to employ.
August 2022
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All indices are unmanaged and may not be invested into directly.
All investing involves risk including loss of principal. No strategy assures success or protects against loss. Any economic forecasts set forth may not develop as predicted.
All company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.
