Seventh pin stuck in the newspaper; Grow Forest Grow

Growth and especially exponential growth is something that not a lot of people really understand. Rest assured though it is a lot easier to grow out of problems than to dig the hole deeper and deeper.

Growth stocks had a wonderful 2020 on average.

This year and 2021 have been pretty terrible for growth stocks though.

Even though some of them have had pretty solid earnings they all sold off this year. Let’s not throw out the baby with the bath water.

A decent quality slowly growing large cap US stock in the second halve of 2020 and 2021 wasn’t easy to find with a price earnings ratio (PE) below 30 times. A fast growing US stock in the second halve of 2020 and 2021 wasn’t easy to find below 60 times PE. Well times have changed. With inflation headlines above 10% a year in some major western countries and central bankers talking hawkish to regain some measure of credibility, some investors might expect interest rates to also go to 10% a year in western countries. That isn’t going to happen though. Negative interest rates are here to stay. Governments have simply grown the debt to GDP levels so high now globally that they will need their central banks help to finance and service the debt. Government’s interest rate payments of 10% on their debts per year would sink most countries and therefore their governments. Already this year we have seen unrest in Kazakhstan (because of high gas prices) and Sri Lanka (because of high inflation and shortages of food and fuel). There will be more “Arab springs” this year. When the poor can’t afford to buy bread or to fill up their motorcycle or car they tend to get very angry fast.

The economy is much more fragile than people give it credit for. In the UK and US the short term interest rates have now gone from about zero to 1%. These short term interest rates can probably be doubled from here to 2% before the economy will really start to hurt and crash into a recession.

The 30 year US mortgage rate has gone up already from 3% in May last year to 5.3% now. High energy prices correlate highly with a US recession as well. Biden’s third round of stimulus checks should have all been paid out by now and there is no chance of a new fourth round. Of course free stimulus spending of other people’s money by Mr Biden raised inflation in the US when the US economy was already running along just fine. The responsibility for the next US recession is entirely on Mr Biden and the FED.

China’s dubious lockdown strategy means China is already in a recession. Unless China wants to be in a permanent lockdown going forward one of the consequences as and when they go back to normal is another Chinese inflation spike higher as that is one of the logical consequences of lockdowns. Of course inflation is a hidden tax that will mainly make the poor even poorer.

The terrible geopolitical situation in Eastern Europe means Europe is already in a recession now as well. The EU really got exposed this year for one major policy error after another in the past. The chickens came home to roost.

The UK in all it wisdom has been raising tax rates this year yet again.  Since the Conservatives came back into power in 2010 their one major accomplishment seems to have been the raising of UK taxes. Of course UK tax hikes in the short term raise the UK inflation rate even more. Long term the UK tax raises are bad for animal spirits and will decrease growth. After all why come out of your bed in the morning to work when the state takes most of the fruits of your labor? Another unintended consequence of the lockdowns seems to be what has been named the “great resignation”. In the UK it is estimated 1 million people have left the labor force. Some of those have simply left the UK; others have retired while it is unclear how another part of those 1 million people now get by. What is clear is that there will be almost no income taxes coming in from those 1 million people.... What was the aim again? Raising UK tax rates or maximizing the amount of UK tax revenue coming in yearly?

With central bankers pushing up interest rates globally the global economy is probably only 6 months away from a recession now if we are not in a global recession now already....

Quantitative tightening (QT) is causing a Mexican standoff between the US stock markets and the FED. Who will blink first? The US stock markets are now again throwing a taper tantrum by going down week after week in order to calm down the hawkish FED talk. Is the FED put still alive? It seems unlikely a politically appointed FED Governor Jay Powell (Chair) will want to be accused of destroying Americans 401k accounts..... Time will tell.

On the QT subject it is one thing for a central bank not to reinvest the proceeds of their bond assets into new government bonds. This decreases liquidity but should be manageable as interest rates find their new equilibrium and the central bank balance sheet will decrease naturally and slowly. It is another thing altogether if central banks will actively start selling their bonds in order to bring down their balance sheets faster. Central banks will then effectively be front running the bond issuance of their own governments. This is the opposite of QE by central banks helping to finance their governments. There is no way this aggressive reducing of the central bank balance sheet will go down nicely in their government circles.

In the past 10 years whenever interest rates went up short term the so called “bond proxies” sold off hardest in the equity markets. These sell offs in bond proxies all provided perfect buying opportunities in the last 10 years. Of course with the help of hindsight interest rates also in the last 10 years continued their downward trend of ever lower interest rates. Bond proxies companies like Procter & Gamble Co, Hershey Co, PepsiCo Inc and Coca Cola Co are now instead trading around all time highs. That is curious. Never say the stock market is predictable or heaven forbid rational. This time the stock market prefers to sell off growth and tech stocks on the fear of higher interest rates. Will this again provide a buying opportunity to go contrarian and buy tech and growth stocks now is the question?

So with a recession looming another question should be which companies will profit most from inflation coming down?

Undoubtedly that will be the growth stocks.

In 2023 we will be in a situation again where growth will be very hard to come by. Inflation is likely to moderate anyway from August this year on wards on the base effect. This time last year it was still illegal for a family in the UK to fly out of the country on a holiday. So there was a very low base of flying going on this time last year in the UK. The “flying inflation” year over year is then obvious going to be huge in the UK until the measure was dropped on the 18^th of July 2021. So only in August 2022 is this low flying base effect going to run out of the 12 month inflation numbers. The UK Coronavirus Act 2020 only expired on the 25^th of March 2022 when UK politicians found it politically convenient to get rid of it after the UK politicians themselves were found out of not following their own ridiculous rules. So there is a global base effect at play in the inflation numbers for 1 or 2 more years at least after countries ditch their Corona laws which will slowly fade from the data. This part of the inflation will be indeed transitory.

Why does compounding favor the highest possible yearly earnings growth over dividend payments and low growth?

Let’s run a little theoretical experiment. We have a paper portfolio that invests $10000 in ten investments of $1000 each in ten different high earnings growth stocks. These are fast growing stocks that actually make money by the way (try to check for GAAP earnings in the US and positive free cash flow). Not the previously fashionable revenue growth with zero profits nonsense stocks. We compare the paper portfolio to an investment of $10000 in the S&P 500 index. We have a ten year investment horizon. 

	S&P 500 index	Return S&P 500 index
Start	10000	10% per year inclusive of dividends
After 10 years	25937
Start	Paper Portfolio
10 stocks $1000 each	10000
After 10 years	7 growth stocks went bust and values zero at end	1 returned 100% per year inclusive of dividends. 1000 turned into 1024000. The PE ratio/valuation stayed the same.	2 stocks returned 30% per year inclusive of dividends. 2000 turned into 27572. The PE ratio of those 2 stocks stayed the same.
Paper Portfolio End Value	0+1024000+27572= 1051572

Dare to dream. An end value of $1051572 thanks to compounding and exponential growth beats the heck out of the $25937 end value after 10 year that the S&P 500 index would have delivered in this example.

For long term investors’ having a diversified portfolio with also some growth stocks in there actually makes sense. It is simply easier to grow your way out of problems. Let’s grow the forest/your investment portfolio. Grow Forest Grow!

Impression above of a 7 year old of Grow Forest Grow...

When you are picking growth companies beware of companies that “grow” by making acquisitions. Usually the managers of those companies use a lot of financial engineering and accounting tricks in order to push the share price up temporarily in order to get rich themselves. Companies like this also pay their employees with a lot of newly issued shares that somehow do not seem to count in their companies cost of doing business. Comparing the GAAP earnings per share (EPS) number versus the “adjusted” EPS number can be a clear warning signal here as well. Long term investors cannot eat “funny” earnings at the end of the day. Growth companies need to be run in order to increase all stakeholders’ value and not just the value of the employees and the managers.

Quantitative investors might explain investment returns with performance with factor building blocks. Investment factors could be as diverse as value, growth, momentum, large cap versus small cap. One thing to keep in mind is that these factors as so many other things in investing go in and out of fashion. When a factor is very fashionable and there is a lot of investment of the fast money crowd into that factor already that factor can become “overvalued”. What that means is that if the popularity and valuation of the companies in the factor group comes back to the mean investors can lose a lot of money when the weak hands sell out of that factor. In a way that is exactly what has happened to the growthy lockdown winners group. On the opposite side of the coin the value factor had been out of fashion since central banks started to finance their governments with the so called quantitative easing (money printing) since around 2009. This year now that central banks have promised to shrink their balance sheets and the Value factor is only down 6.8% year to date (YTD) and the High Dividend Yield Factor is only down 3.6% YTD (data based on Seeking Alpha website). The S&P 500 is down 15.42% YTD. The Growth factor is down -23.14% YTD and the Momentum factor is down 21.7% YTD. Dancing with fashion can be a dangerous hobby indeed. The value factor may now include growth stocks.

It is about time to stick the seventh pin into the quotation page of a financial newspaper and pick a (none Euro listed and none £ listed) stock. It makes sense to aim for a $ listed stock this time for diversification reasons and according to the investment plan of the book Beat the Stock Market Casino.

First though let’s have a look at how the monkey and crayon portfolio have done so far.

The monkey portfolio is under water and losing money now. The monkey portfolio is down $2219 or around 5.9% (excluding dividends) according to the Sigfig.com website since inception. Luckily the dividend adjusted return is actually higher for the monkey portfolio. The Stockrover website for example guesses that the current monkey portfolio will pay $1687 in dividends in 2023.

The crayon portfolio was luckier so far. The crayon portfolio is up about $14113 or around 38.1% (excluding dividends) according to the Sigfig.com website since inception. The crayon portfolio has given up a lot of its previous winnings this year. There were a number of holdings that were up 100% plus previously that have come back to earth in the crayon portfolio. That shows the wisdom of selling halve of your stock holding value when the stock is up 100% plus from where you bought it and re-investing the proceeds in something totally different and as uncorrelated as possible. The real performance difference between the monkey and the crayon is less than it appears as the current crayon portfolio will pay lower yearly dividends than the monkey portfolio. The crayon portfolio will only pay $619 in dividends in 2023 as predicted by the Stockrover website.  

Above; Crayon portfolio value over time chart from the Stockrover website

 Because the monkey portfolio now loses money the seventh position will have a new position value of about $7500 according to the “no capital gain taxes growth investment plan” in the book ‘Beat the Stock Market Casino’. The investment plan makes sure of higher $ value bets when the stock portfolio loses money. Simply put when the market is down the odds of buying is stock that goes on to double or more long term is higher. So a down market when the stock market is flashing a “for sale” sign can be an opportunity for long term investors. On that note have you noticed that Warren E. Buffett has been putting cash to work again this year for Berkshire Hathaway? Borrowing a Warren E. Buffett quote from the CFP SDL Free Spirit Fund Factsheet of May 2022;

“The market has been extraordinary. Sometimes it is quite investment oriented... and other times, it’s almost totally a casino, and it’s a gambling parlor.”

Have you bought the book “Beat the Stock Market Casino” yet on Amazon?

The crayon portfolio follows where the monkey portfolio leads to keep things simple and comparable. 

Beating the S&P 500 index would be nice, but first things first let the portfolios make more money than cash on a bank account as in retirement that would be a good start as that is one of the alternatives in the asset allocation.

 

Clearly a portfolio with only six holdings so far is still way off from a diversified portfolio... So both the monkey and crayon portfolio are still extremely risky, but the plan is to add another holding to both portfolios every 6 months so both paper portfolios will get diversified eventually... Plus both portfolios are being “time diversified” as well and at least that is reducing risk.

 

The monkey has no opinion and no knowledge. Just sticking to an investment plan and throwing darts at the quotation page of the FT or Wall Street Journal will do the trick of making money. Holland Park Capital London would bet that the monkey portfolio after another 8 years will consistently make money. Time in the market and a diversified portfolio are hard to beat. Put your money where your mouth is. While the monkey and crayon portfolios are paper portfolios, Holland Park Capital London has a holding in all the stock holdings of those portfolios. Just not the same amount of shares per holding as the paper portfolios.

 

For the seventh round the green highlighter landed on the US listed stock Equinix Inc with code EQIX of the quotations page of the FT newspaper. For the monkey portfolio a paper transaction was added to the paper portfolio of 11 shares at $662 (on the 13^th of May 2022). That transaction had a value of about $7300. This time the monkey portfolio has selected a REIT stock. And this REIT is an expansive one (115 times PE) at that. The Equinix dividend yield is around 2% which is not high for a REIT stock. It is good to see the monkey portfolio not again selecting a value stock. On the internet the data says that Equinix has grown its yearly net income by 34% a year on average for the last 5 years. For diversification reasons it is great news that the monkey portfolio will now finally add its first growth stock. 

Above; FT newspaper green marker landed on the US stock Equinix for monkey stock pick

For the crayon portfolio a paper transaction was added to the crayon paper portfolio of relatively unknown growth stock Inmode Ltd with code INMD listed in the US so also in listed in the $ currency. For the crayon portfolio 296 shares of Inmode at $24.6 were selected for the paper portfolio (also on the 13^th of May 2022). That transaction value on paper was about $7300 as well. On the internet the data says that Inmode has grown its yearly net income by 245% a year on average for the last 5 years. Inmode shows now as having a Price/Earnings Growth Ratio (PEG) of 0.05. It doesn’t come much lower than that. Inmode has a price earnings ratio (PE) now of around 12. 

So Inmode is a growth stock, but a value stock as well! 

Inmode’s stock price implies that the stock market thinks that Inmode’s net income earnings will decrease in the next couple of years. Maybe yes. Maybe not. Time will tell. Inmode’s growth rate is highly unlikely to keep up the previous growth rate in the next 10 years and is likely to disappoint. As the saying goes; “Returns from the past are no guarantee for the future.” Then again there is a very small chance Inmode keeps growing nicely and that is nice call option for the crayon portfolio. Hopefully the share price of Inmode does not go to zero in the next ten years... Grow Forest Grow! Inmode can be seen as a little sapling addition to the crayon forest. Hopefully the little Inmode sapling can grow into an old forest giant of the crayon portfolio in the next 10 years or more.

Both paper portfolios have 7 holdings now. Slowly but surely the portfolios start looking a little like diversified portfolios. May the force be with both paper portfolios. Thanks for reading this blog.

Holland Park Capital London hopes you enjoyed the information in the blog. Holland Park Capital London Ltd is not receiving any compensation from anyone to write this blog. Holland Park Capital London is long the stocks in the crayon portfolio and the monkey portfolio. Holland Park Capital London Ltd just doesn’t have the same amount of shares per holding as the paper crayon and monkey portfolios. Holland Park Capital London Ltd is also long the S&P 500 index. Holland Park Capital London has no business relationship with any company whose stock is mentioned in this blog. Holland Park Capital London expressed its own opinions. This is not advice. Make your own decisions please. Do your own research. Please go and see an authorized financial advisor before making any investment decisions. What works for Holland Park Capital London may well not work for you and your personal situation is unknown to Holland Park Capital London. Stocks go up as well as down and you may get back less than you invest. Your capital is at risk when you invest in stocks. In other words you can lose all your money by investing in stocks.

 

Any information in this blog should be considered general information and not relied on as a formal investment recommendation. This blog is for information purposes only and helps Holland Park Capital London expand on the book “Beat the Stock Market Casino” and brings extra discipline in the investment process. Holland Park Capital London Ltd is not liable for any mistakes in this blog. This blog cannot be a substitute for comprehensive investment analysis. Any analysis presented in this blog is illustrative in nature, limited in scope, based on an incomplete set of information and has limitations to its accuracy. The information upon which this blog is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore the accuracy cannot be guaranteed. Any opinions are as of the date of publication and are subject to change without notice.