Long-Term Investing Ideas in a Volatile Market
Simon recently spoke with a $35 billion global asset manager about how they're navigating the market volatility. The key takeaways are to think long term, tune out the noise...
Retired money manager Puru Saxena shares his thoughts with 7investing CEO Simon Erickson about inflation, interest rates, and what's on the horizon for the stock market in 2022 (and beyond).
May 11, 2022 – By Simon Erickson
Things are getting dicey out there, and it’s shaking the resolve of quite a few investors.
The stock market has spent the past half year in a free fall. The S&P 500 is down 17% from its December highs, while the tech-heavy Nasdaq is down 28% from its peak in November. Many individual stocks are faring even worse, with some down 60%, 70%, or more from their previous highs.
Shell-shocked investors have been searching for the reasons behind the current market hysteria. Many believe the culprit of this year’s severe selloff is due to the headwinds blowing in the face of the US economy.
American inflation hit 8.5% in April, which is the highest annual increase in more than forty years. The Fed, looking to tame that inflationary beast, has driven up interest rates aggressively in recent months. Higher rates make it more challenging for consumers or businesses to borrow, which tends to slow down the expansion of the economy.
And the report card of the business world is the stock market. Always forward-looking, stocks have sold off in anticipation of the economy’s upcoming struggles. Slower growth and rising interest rates are both net-negatives in the calculations of a stock’s intrinsic value (all other things being equal).
So what are investors to do?
Is now the time to be aggressive, being greedy when others are fearful and buying up bargains when there’s blood in the streets? Or is it time to get defensive, prioritizing cash flows and a strong balance sheet as the most important factors of consideration?
Furthermore, how long will these macroeconomic issues last for? What would happen to stocks if the US goes into a recession? Or conversely, are there new opportunities that might arise like a phoenix out of this crisis?
To help us answer those questions, we’ve brought in an expert. Puru Saxena is a retired money manager who is now an individual investor. He’s spent more than twenty years monitoring indicators and analyzing market cycles, deciphering what they all will mean for stock market investors.
In this exclusive interview, Puru chats with 7investing CEO Simon Erickson about several important topics. Puru explains what the Fed’s recent rate increase will mean for the economy and how it should be interpreted by investors. He describes his expectations for the stock market in 2022 and why tech companies could be poised to outperform during the next three years. The two discuss the winners and losers from inflation, why market timing is so difficult, and how to interpret the recent yield curve inversion. They also predict the likelihood of an American recession and how investors should think about valuing technology companies.
In the second segment, Puru and Simon discusses several individual stocks they find intriguing. Simon notes that large tech companies like the FAANG (Facebook, Amazon, Apple, Netflix, and Google) have been responsible for much of the last decade’s bull-market gains, yet there has been a divergence in their performance post-COVID. Puru describes several companies he believes are well-poised for the future, including QuantumScape, MercadoLibre, and Nu Holdings.
In the final segment, Puru talks about position sizing and how investors can think about hedging as a way to protect their portfolio gains.
We’re thankful for Puru sharing his insights with our audience. If you’d like to continue the conversation about interest rates, inflation, or the economy, please bring your thoughts to our 7investing Community Forum.
Publicly-traded companies mentioned in this interview include Alphabet, Amazon, Apple, MercadoLibre, Meta Platforms, Netflix, Nu Holdings, QuantumScape, and Zoom Video Communications. 7investing’s advisors or its guests may have positions in the companies mentioned.
00:00 – Introduction
00:51 – The Fed’s actions and the state of the American economy
03:08 – Growth-style investing in a rising rate environment
10:29 – The winners and losers from inflation
14:25 – How to interpret the yield curve inversion. Is the US headed into a recession?
18:17 – How the stock market performs during recessions
21:29 – How investors should think about valuing technology companies
26:22 – Investing in Big Tech. Why is there a divergence of the FAANG?
34:14 – Individual companies: QuantumScape, Nu Holdings, and MercadoLibre
46:37 – How investing in Southeast Asia is different than America
47:23 – Diversification and position sizing
49:08 – Hedging as a way to protect portfolio gains
53:14 – What investors should expect in 2022
Simon Erickson 00:00
Okay, hello, everyone, and welcome to our 7investing podcast where it’s our mission to empower you to invest in your future. I’m 7investing founder and CEO, Simon Erickson, we’re gonna be chatting about the macro economic picture today. Got a big announcement from the Fed that we’re going to dig into. We’ll chat about inflation, we’ll talk about interest rates, we’ll talk about what all this will mean for you, as an investor in the stock market. But who better to talk about the macro. There’s no better investor out there to chat with when it comes to macro economic events going on than Puru Saxena. Puru is an individual investor now he’s a retired money manager, I think he’s just got a great kind of pulse on what’s going on reads the tea leaves very well. He’s gonna chat a little bit about what he’s looking at in the macro economic picture.
Puru it’s always a pleasure having you on our 7investing podcast. Thanks for joining me.
Puru Saxena 00:48
My pleasure. It’s always great to chat with you.
Simon Erickson 00:51
Puru we’ll dig into a lot of those right, we’re gonna dig into interest rates, we have a lot to talk about when it comes to inflation and growth, style investing and valuations. But maybe let’s start at the 10,000 foot level, right, just today. We’re recording this on Thursday afternoon in the US, Friday morning if you’re in Hong Kong. But just today, we got an announcement from the Fed that Jerome Powell stated that we’re going to be expecting to raise interest rates by 50 basis points. So half a percentage point. A lot of people responded very positively to this, the market certainly love it, because some are expecting a much larger rate increase than that, of course, the Fed is very interested in controlling inflation in the economy. But 10,000 foot level Puru, what did you make of the Fed’s announcement earlier today? And maybe even more broadly than that, what’s the state of the American economy right now?
Puru Saxena 01:36
Well, Simon, the economy is slowing down pretty rapidly because monetary policy, liquidity, drives the business cycle both on the way up and the way down. We had huge amounts of stimulus, both monetary and fiscal, in 2020, in response to COVID and the lockdowns. Basically that caused a massive boom, both in the economy as well as the financial markets. As you know stocks went 4x, 5x, 6x, 7x, in a year, and they were basically a huge bubble. And then the Fed started coming after inflation, it signaled last autumn that this inflation was no longer transitory that they were behind the curve, and that they were going to reverse policy pretty abruptly to try and bring down inflation. So that caused the reverse to happen. We have the boom. And then we have the contraction, the post bubble contraction, which has been playing out in the markets over the last five or six months, maybe a year. In the case of the SPACs, the most risky segments of the market. They peaked in February, Jan, Feb last year. So the carnage has been going on for about 12 to 15 months.
So my view is that the economy is slowing down pretty sharply, I suspect that the PMIs in the US will come down to maybe 2051, 2052, 2053 maybe around that sort of level. So they will be an impact on the economy because of the Fed’s policy shift. And the financial markets have been discounting this for the last five or six months, the indices topped in November.
Simon Erickson 03:08
There’s a lot to unpack there. But let’s let’s focus on the growth style investing that you just mentioned, because I’m really interested in that as well as the type of investor that I am. But we’ve seen the money has been very cheap, right? Since the great financial crisis 2008, interest rates were very low. So a lot of companies put their foot on the accelerator, it didn’t really matter if you were burning cash or cash flow negative, because you could always raise money, either at a very low interest rate or just issue stock equity when you when your stock price is very, very high.
Puru Saxena 05:11
So now we’re sort of five, six months into the sell off. It has been pretty gruesome and brutal if you are invested in anything, which is basically long duration, especially in growth stocks. The NASDAQ is down. A lot of the NASDAQ stocks are down a lot 50, 60, 70%. Some of the growth stocks are down 70 or 80%. So the market has already been discounting the Feds policy shift and also the slowdown in the economy. And I think that the growth stocks are pretty much washed out here. A number of the high quality growth stocks did not break their March lows during the recent bout of selling, which just concluded yesterday. So I suspect that we are going to get at the very least a sharp counter trend rally a relief rally in stocks over the next few weeks, perhaps at least over the next 10 days to two weeks or so.
My view is that the growth stocks, the risk reward is very, very favorable if you have a two or three year timeframe, because I think that because of the carnage over the last year or so Simon, they’re down 70 or 80%. And the valuations have become pretty reasonable for the vast majority of these companies. And my feeling is that the CPI is going to roll over. So the inflation which everyone’s worrying about is probably peaking now, and it will roll over because of what the Fed is doing. And monetary policy always works but with a lag. So I suspect that inflation is going to roll over. And long term bond yields are also in my opinion pretty close to an important peak. And when the economy basically decelerates inflation rolls over I think bond yields, the long term bond yields are also going to start sliding. And that’s going to be good news for the long duration secular growth stocks because when the economy is weak, and the rest of the businesses are struggling, the cyclicals are struggling commodities are coming under pressure, then the secular growth stories which are not really dependent upon the economy become attractive for investment dollars.
And I think we will start to see that shift, pretty much the reverse of what has happened over the last five or six months, I think the beaten down growth stocks are likely to outperform over the next 12 months or so. And the stuff which is already currently beat up the defensive, the division stocks, the energy, commodities, and so forth, I think they are more vulnerable at this point, because they’ve had such a sharp rally.
Simon Erickson 05:48
We’ve seen that contract like you mentioned from the last six months, the indices hitting the top in November, we’ve seen a sharp correction and bear market for the NASDAQ even. And as you mentioned several of those companies down even 50 or 70% from their highs. Again, you mentioned that you think that a lot of that pain might already be baked in with the valuations. But do you think that growth style investing still continues in the same form that we’ve seen for the last call it 12 or 13 years where money is cheap? And that was kind of the okay for managers to be a little bit more aggressive? Or do you think that kind of these companies that have their cash flows in the future do they reign it in a little bit more and kind of profitability and cash flows are a little bit more important now?
Puru Saxena 07:02
Well Simon, this is an interesting thing, because I’ve read when growth stocks go down, the value crowd comes back and says, we told you so, but the time to be negative towards growth was not now it was last year when they had gone up five or six times in a year, when I was cautioning people that this was a bubble. And this was going to basically cause problems when the Fed reverse course, I used to get a lot of hate comments saying you’re an old 40 year old geezer, you’re talking about this is the new paradigm digital transformation. And all the buzzwords, which are typically associated with a raging mania, that was the time to be defensive and cautious of growth, because obviously, after a 70 or 80% drawdown its going to take a long time for those people to basically get their capital back perhaps three or four years. So that was a time where the risk reward was extremely unfavorable for growth stocks.
But if you are looking today, we’ve already had a 70 or 80% drawdown and the vast majority of growth companies somewhere around 50 60%, the best quality names around 50, or 60%. Now, if you look at what happened in the TMT bubble, which is the telecom media technology bubble, when the bubble popped in early 2000-2003, so that was basically a three year bear market. And in that bear market, most of the tech stocks went down maybe 70 or 80%. And those investors who ignored the negative headlines and the negative sentiment, and they were brave enough to invest after a 70 80% wash outs in those companies, in the good ones, they made an absolute fortune over the next 10, 15, 20 years. And I think something similar will play out now. I don’t think all the companies are going to reward shareholders, the rubbish ones, they’re not going to come back, a lot of these companies are never going back to the all time highs. But if you invest in the really good ones where the cash flows are strong, and the margins are trending in the right direction, the leadership is strong, the revenues are strong, and the market positioning as strong, there’s not much competition, those businesses should be within the new all time highs within four or five years, I would imagine. I don’t think that this is the end of the road for the really good companies.
So the really extraordinary businesses, they will be back to new highs in five years, four or five years from now, and that may seem like a long time but if you think about it, if something was at 100 is now at 30, to get to 100 it’s basically you’re getting what you know 300% return, basically tripling your money from 30 to 100. You’ve tripled your money. And basically you know if you do that in four or five years that’s a pretty decent IRR isn’t it? So I think those investors who ignore the various chatter, and are intelligently investing in these very companies that these de-risked prices are going to do very well. Now, I’m not smart enough to tell you what these stocks are going to do next week or next month, they may come up, come off a little bit more. But I do know that if you are buying these companies at these reasonable valuations, I think investors are going to generate a very healthy IRR over the next several years.
Simon Erickson 10:29
Yeah, it makes a lot of sense Puru. For years before it seems like such a long time ago but before COVID there was already this digital transformation that was underway, that was kind of the buzzword that was sticking for anyone who was a tech investor, anyone who’s a growth style investor, then COVID happens and everything has to happen online. So it seems like that and the low interest rates just accelerated a lot of this. We forget it at the time now, because we’ve seen these contraction and so many of these stock prices. But there was such a pop in the tech companies just over a short period of time there. That’s now back to normal. It’s it’s kind of interesting to see that working out the other way.
I want to touch about on interest rates in a minute here. But let’s get back to inflation just a second. Because you mentioned margins and profitability and cash flows, the CPI was up 8.5% In April, that’s the highest rate of increase that it’s seen in 40 years, since December of 1981. And yet unemployment still at 3.6%. Right? It’s a low unemployment. So anything, economy’s clipping right along very, very quickly. And that’s why we think the Fed is doing what it’s doing. But do you think, what parts of the economy do you think are most sensitive to inflation? I know that energy has been one of the largest contributors to that top line inflation number. And so if you have shifts in logistics going across the globe, of course, you’re going to be exposed to that. Maybe software companies not as much, but what’s your take on inflation? Who are the winners? Or who are the losers from inflation? Or do you really just not worry about this as so much as an investor?
Puru Saxena 11:58
Well, if you’re going to play the macro game of jumping in and out of different sectors and industries, it’s a very difficult game to play. I don’t know anybody who gets it right consistently. So I don’t bother. But if coming back to your question, I think the companies are the industries which benefit from rising commodity prices. And these bottlenecks we’ve seen in the supply chains. Those have been the big beneficiaries, from this inflation, and also this money printing. The companies which can’t have sort of pricing power, and which are dependent on discretionary spending from consumers, they’re the ones which basically end up feeling the pain because consumers don’t have as much money to spend, because the purchasing power has diminished when you have more of inflation, and prices go up. So coming back to your question, I think, I believe that inflation is peaking, and inflation will gradually come off for the rest of the year. And in this scenario, I suspect that commodity prices are most vulnerable, especially if you have a deceleration in the economy, then I think commodity prices are going to come off over the next few weeks few months. And the commodity producers energy and all these miners and so forth, which have done really well over the last six, eight months, are likely to come under some severe pressure. The beaten down stuff, which was knocked down pretty hard, the long duration growth stocks, I believe, now very reasonably valued. And they are currently offering a pretty decent medium to long term IRR potential for investors.
For my part, Simon, I don’t play the jumping from industry to industry game, because it’s very difficult, it’s very difficult to know when to come in and get out into certain things. So for me, I’ve just been holding shares of these long term growth stocks the software companies, the E commerce companies, online payments, and so forth where the management teams are brilliant, revenue growth is strong, the operating results are strong, and the valuations are very low. So I suspect in over the next four or five years, I’ll be very surprised if I don’t generate at least a 20% IRR on my investments, which would probably triple my portfolio over the next five years or so. And that will be pretty decent return. I don’t think the S&P is going to triple in the next five years or the energy companies they’ve already had their day in the sun and I think they’re due for a pullback.
Simon Erickson 14:25
It really is true Puru I certainly agree with you. It’s tough to jump in and out. It’s not that long ago that we remember gas tankers, oil and gas tankers sitting, they can’t just be taken because they can’t sell the oil and then the harbours and then here we have energy was the best performing sector of the S&P last year up 55%, which is kind of incredible, especially with as strong of a market as we had.
Let’s touch on interest rates. Again this is something you said was that “monetary policy is what creates booms and busts and this has been the case for 100 years.” I love that quote, certainly true. The 10 year Treasury is now at about 3%. But it’s risen very, very quickly. It’s up 100 basis points in just the last three months. And the two year treasury is at 2.6% now, that’s up 130 basis points in the last three months.
But there’s something interesting that happened on April 1, just about a month ago, Puru, which is that we saw an inversion of the yield curve, it’s normal where the 10 year treasury has got a higher rate of return than the two year treasury. But that was flipped on April 1, where the shorter term duration bonds had higher interest rates than the longer term. And we call that the inversion of the yield curve. To show how rare this is that’s only happened four times in the last 25 years. And in each of those previous instances, which were in 2019, 2005, 1998, and 1988, there was a recession that followed after that. It’s almost a predictor of recession, at least in the US economy, at least in the near future in the near past. Can you talk about kind of if you follow the inversion of the yield curve, why that’s so significant? And do you think this is predictive of an upcoming recession in the US economy?
Puru Saxena 16:10
Simon I do follow the yield curve I have done for the last 15 years or so. But the yield curve has not yet flashed a valid inversion signal, because if you go back into history, and then you see these periods, which you mentioned, which is the inversion, which is where the short term interest rates are temporarily higher than the long term bond yields, and you will know that only in those instances where the inversion was persistent, did we actually get a recession afterwards. And not immediately, in some cases, it took 12 to 15 months after, or maybe 18 months after, in some cases before the economy slipped into a recession. This time around, we only had an inversion, which lasted maybe one or two days. And that, in my opinion, is a fake false signal. It’s a head fake in basketball terms, which means that is not really a valid signal. And also, if you look at the three month and the 10 year spread, which is the spread between the 10 year Treasury yield, and the three month treasuries, that has never inverted at all, during this cycle, only the two year have inverted.
And then as soon as the inversion happened, what did the Fed do? The Fed sent out we’ll add in a few other hooks, and they started talking about quantitative tightening. And that’s what caused long term bond yields to really take off over the last month or so. So they effectively steepen the yield curve, the Fed on purpose to avoid the recession threat. And there’s all this jawboning by the Fed officials over the last month or so it was done purposely to steepen the curve. And they’ve managed to do that. So at the moment, the yield curve hasn’t yet flushed and economic recession signal, I usually look at a persistent inversion which lasts for about 60 to 90 days. We haven’t had that yet. If we do get that at some point this year, then that would be a signal that a recession is coming, perhaps in 2023, or 2024. But we don’t know yet.
Simon Erickson 18:17
That’s a great point Puru. And before I scare everybody off and they turn off this podcast and start loading up on ammunition and beef jerky and heading for the hills, even a recession might not be doom and gloom for the stock market.
The stock market is kind of predictive of the future state of the economy, stocks fall first before even recessions take place. In fact, there’s some interesting research from LPL research here that says that even in those four previous inversions, which is you mentioned Puru, this only happened for a couple of days, not a prolonged period, like you mentioned. But even in the four instances before this, the s&p gained an average of 29% up from its low, even through the recession over the next average 17 months. So the stock market tends to be predictive of things like this, even as the economy is struggling. It seems like a lot of that has already baked into the expectations, especially for pessimistic expectations.
Puru Saxena 19:08
For sure, I mean, the stock market looks ahead. The stock market tops when the best has been discounted, and bottoms when the worst has been discounted. So the news trails the financial markets, the news is always rosy and wonderful at the top of the cycle when your economy is strong, stocks are at record prices, corporate earnings are a strong, that is when equities peak. Conversely, stocks bottom when the worst has been discounted and stocks and bonds on when the news is absolutely scary and frightening and dire. That’s when stocks tend to bottom. They don’t bottom when things have improved because by then prices are 20 or 30% higher or 40% higher in some cases.
So I don’t really have a firm view at the moment as to whether the US economy will go into recession. If somebody put a gun to my head and said or asked me, I would probably say I don’t think we are going to see a major recession this year. And I don’t think that this is similar to the 2008 2009 cycle, because that was a horrendous banking crisis, a housing bust, which caused almost all the banks to wander in the US and, indeed, in most of the developed countries. We don’t have similar excesses right now. We’ve had excesses in the equity market, which have largely been corrected now with the 70 or 80% declines in the growth stocks and the valuations are now back to the historical averages. For growth stocks, at least, the S&P and the Nasdaq are still mildly elevated, maybe 10% or so. But the equity risk premium hasn’t really blown out. The equity risk premium is still pretty sort of low. And as long as that is the case, who knows, we may get another 7% or 10% downside in the indices. But I don’t think we’re gonna see a 40 or 50% crack from here simply because the S&P is now trading or sort of 17 and a half times evened earnings. and the NASDAQ came off throughout 2021. So we may have some more additional selling Simon. Nobody really has a crystal ball. But I think, especially for the growth stocks, I think most of the carnage is now in the rearview mirror. And this is the time to go shopping, not to panic. In my opinion. I could be wrong, of course.
Simon Erickson 21:29
Great, great points. Let’s chat a little bit about those historic valuations.
It was, I guess, it was more than a little more than a decade ago now that Bill Gurley the very famous venture capitalist out in Silicon Valley pins his now-famous blog about the 10x revenue club, right? He was saying that it was aggressive that some companies out there, this is again, a couple of years removed from the.com burst, were now selling at 10 times sales, Puru. And he applauded companies like Netflix that were going out there and creating subscription models that weren’t so much based on transactions or advertising. Of course, we just blew that one out of the water, we saw Zoom Video Communications selling at 40 times sales, not that long ago. And it seems like a lot of the market got really, really excited. Of course, it’s not just subscription models, but it’s more recurring revenue. It is subscriptions, but a lot of it’s locking in larger enterprises with cloud based solutions that are at very, very high margins.
But the nature of my question here Puru is do you have kind of a rule of thumb or a way that you think about what a realistic valuation is for tech companies? So is there a rule of thumb, whether it’s price to sales, multiples, EV to EBITDA, anything even unrelated to those, but how do you think about what’s a good valuation to pay for a big tech company?
Puru Saxena 22:44
Well Simon it depends on whether the company is profitable or not. And I know at the moment that everybody hates unprofitable companies, simply because everyone wants to see profits now. And I think that is a mistake, because those companies which are reinvesting in their business aggressively to try and grow and capture as many customers and market share as they can, in my opinion, they’re doing the right thing, and they may not be immediately profitable.
But a lot of these companies can be profitable tomorrow if they want to. They are unprofitable by design they spend a vast majority of the revenues and cash flows in spending S&M, sales and marketing, to try and grab as many customers as they possibly can because all these customers then keep sending them checks month after month, quarter after quarter because of the subscription models. So in my opinion, at least they’re doing the right thing, I don’t think they should be slowing down just because shareholders have decided suddenly that immediate near term profitability is more important than the long term target. So, coming back to your question, I think for the profitable companies, I look at the EPS growth of the company, I look at the earnings per share as earnings per share and the growth rate and then I look at the valuation based on earnings multiple or I look at free cash flow, those companies which are investing heavily and they don’t currently have any sort of free cash flows or profitability, I look at the sales multiple, the earnings, EV to revenue multiple and compare that with the past over the last five years or so, what the average has been, and then I try and assess what these companies will be earning the revenues and cash flows for five years into the future.
And then I apply a reasonable multiple on that number to try and see what the market cap will look like four or five years from now versus where it is today. And then I calculate what the IRR would be. So if the market cap according to my calculations is likely to be double from where it is today, five years from now, that equates to a 15% return for me as a shareholder, you know give or take share dilution. So these are some of the rough numbers that are calculated because there is no perfect science in this. You have to use Is your own judgment based on what has happened and my history and everything else. But these are the sort of metrics I look at. And obviously, a major component of that also is the competitive position in the business because a lot of these companies promise a lot. But then you have competition, something comes along, and then they can’t meet those numbers. So I think competitive positioning as Warren Buffett calls moat is very important when you’re investing in long duration assets, which are growth companies because obviously, if those numbers don’t materialize, then the stock gets clobbered. And as we’ve seen recently, they go down 30 40% in one single day. So it’s not for the faint of heart. And it’s not very advisable to invest all your portfolio in maybe five or seven companies, which a lot of people seem to do, I think that’s too risky. Research has shown that if you have a portfolio of around 20, companies, it gives you all the diversification that you need a visa vie an index. And if you were any more than 21, you do companies, and that only waters down your accounts. So that is diversification, who RSI diversification. So, for me, I tend to focus in the sweet spot on 18 to 20 companies, and some of them don’t work out. But position sizing is pretty small. So even if I hate on a couple of them, it doesn’t really affect my total portfolio by much.
Simon Erickson 26:22
I like the approach to growth style investing Puru looking kind of at the larger market, and then kind of back calculating out your your IRR.
Just to add something to that I’m also a big fan of innovation of growth style investing too. And my perspective on this is there’s such scalability, and a lot of these models that are digital, that are doing business on the internet that are software companies, it’s totally fine that some companies out there are the Walmarts, or the Chipotles or the Starbucks that just grow linearly. And any any Wall Street analyst that’s worth his salt is going to be able to predict those and kind of follow along with what multiple would make sense for those companies.
But the scalability, the S curves, we always talk about the disruptive innovators that are out there, they can grow very, very quickly in ways that nobody was expecting. And a lot of times those price targets are trying to just keep up with a company that’s not out of the park. Certainly we’ve seen that with Tesla blowing past expectations in recent years, certainly doable in tech, as well as you have very scalable software software models. So I love this approach. I wanted to chat a little bit about the larger technology companies, right.
We’ve seen so many of the gains of the S&P 500 of this past decade coming from its largest constituents, which are now technology companies, right, the fang companies, Facebook, Amazon, Apple, Netflix and Google. And a couple of those in there have changed names recently. But it’s the same big tech companies, right, that have just done phenomenally well in these last 10 years. But we’re starting to see a divergence, right? They’re not all going lockstep up together. Facebook and Amazon have certainly in Netflix have certainly been struggling, at least in this last year or so. Well, well, Google has been doing just fine. And then Apple seems to be doing just fine, too. What’s your take on big tech companies? What do you think about the FAANG companies this is divergent is going to continue? Are they going to still be the best performers for the next 10 years?
Puru Saxena 28:15
Well, I think there’s going to be divergence, simply because the last 15 years or so when or 20 years now, when the internet really took off, a lot of these businesses basically became possible because of the internet. The Googles of this world, Facebook’s social media, you had the smartphone, which was made possible because of the internet. And Netflix, which is also streaming. Amazon, which was made possible because of the internet, e commerce. So these businesses basically were leaders, and they developed their own categories, if you will. And they grew and grew and grew and grew because they were virtually like monopolies. Global monopolies are droplets. And they were able to grow rapidly for a number of years. But the problem is, after, you know, growing so much for the last 20 years or so they’ve become really big, you know, that is a problem. I mean, scale is a problem eventually becomes a problem for everybody. So if you have, you know, a 50 billion revenue run rate, you’re not going to grow at 30% a year, there is only so much market you can capture. And even if you you know come up with a new business line or two, in the beginning, that business line is not going to even move the needle because your other core business is going to be so large.
And I think that’s what we’re seeing today in the FAANG stocks. I think they’re past their prime. They’re no longer the secular growth stocks. They were attentive to, you know, even five years ago because they’ve become so large. And you can see that from the growth rate. The growth rates are now down, you know, the fangs are growing at maybe 15 20% A year revenue growth if they’re lucky. And I think you know, the baton has been passed on already to the next generation of these growth secular compounders. I don’t think the fangs are going to be The market leaders going forward over the next 10 years or so I think a new the new generation of growth companies are going to power the indices forward. And coming back to your question about, you know, only a handful of companies being responsible for the vast majority of the gains in the indices. While this has been the case, for 100 years, you know, research has shown that over the last 100 years, only four or 5% of the stocks have actually powered the vast majority of the growth or the gains in the industries, which is remarkable figure when you think of it. So 96% of companies in the indices over the last 100 years, haven’t done anything for the growth for the gains from the industries, and only the select handful of great companies at that time, I’ve basically been responsible for the vast majority of the growth of the gains in the industry over the past century. So I mean, in that regard, this is nothing new.
As investors, you know, our job has to be defined, identify the very best companies, which will be able to grow and grow and grow over the next five to 10 years. And that’s where you’ll make your money. And, you know, growth, investing to me is the most logical way of investing, simply because once you identify a great company, and if you basically get in at a reasonable price, you don’t have to do much, you know, you can just be a shareholder of that company for the next eight to 10 years. And as long as the company is executing, and there is no competition, and the competition has been kept at bay by some characteristics of that business, then you can pretty much make a pretty good return as a shareholder. And if you divert into value investing or playing, you know, the timing game, then the game becomes harder, in my opinion, because if you are, you know, looking at investing, so cheap, beaten down stocks, ie commodities, when they’re low, other cyclicals or the value stocks, which become very cheap from time to time, then you cannot buy and hold those for the next five or seven or eight years, because at some point, the valuation will come back to normal. And as the old said, they can’t grow anymore, because there is no underlying growth in the business. And then you have to, you know, sell them and look for the other bargains. So it is a much more active game. And it’s a lot harder, in my opinion, at least than investing in, say 20 world class companies, which you know, are going to grow and grow and grow over the next five to seven years. And that game is a lot harder. And if you look at, you know, the past performance, going back 4050 years, the biggest winners in the stock market have been those companies, which have been able to grow rapidly for long periods of time, you know, whether it’s McDonald’s, Starbucks, Home Depot, or Walmart, you know, I’m not even talking about tech companies, Nike, any business Monster Beverage, so the biggest companies have been those which have actually been able to grow and grow and grow for a very long period of time. Tesla.
So you know, this thing that, you know, people think, oh, you know, tech investing is growth, investing, I think is a misnomer. The reality is that if you invest in solid business, which will, you know, capture a lot of market share 510 years out, it doesn’t really matter which industry it is, as long as you know, there is growth, there is profitability, and free cash flow, that’s all investors worry about. And it just happens to be that, you know, these leaders in the tech space are able to, you know, grow and compound with very little capital requirements. And that’s what attracts me to these companies. You know, if you invest in, you know, a car company or any other industry, then you have to spend a lot of capital generally, to be able to grow. Whereas if you are a software business, or an E commerce business or an online payments business, then your capital requirements are a lot lower, and every new customer basically is directly to your revenue and customers and bottom line. That’s what I like about these companies. So I think nothing has changed in the investment world. You know, even over the next 10 years, those shareholders who invest in these strong growth stories, these businesses, which are likely to be a lot bigger, 10 years from now, if they get in at a reasonable valuation, they will make money hand over fist. And this has been the case for the last 100 years.
Simon Erickson 34:14
Let’s chat about some of those growth stories. Maybe some that are a little less familiar than the fang companies that everybody’s seeing a zillion headlines written about. We had a question come in from Twitter that actually mentioned that you’ve been chatting recently about QuantumScape, ticker on that is “QS”. And then also another company Nu Bank Holdings, I’m sorry, Nu Holdings, which is a digital bank. And the ticker on that is NU and that’s a digital bank that has a presence in South America. Now, those are less familiar names Puru for a lot of people, but would you like to chat about either of those companies or perhaps any other company that’s a little bit smaller, a little bit less familiar that has your attention right now.
Puru Saxena 34:47
So I mean, we can briefly discuss both if you like. QuantumScape is my play on clean energy, and also EVs in quantum scape is developing solid state lithium battery, the company’s management team is pretty switched on the old Stanford graduates, the company is, you know, well funded in terms of shareholders, the raw, pretty prominent shareholders, which basically own shares in the business. And they have been putting out data over the last 12 or 18 months or so where they have shown that they have got their technology. And now it’s only a question of scaling up this technology and building bigger battery packs which can be used in commerce. Volkswagen owns I think about 10% of the company. And they have already signed an agreement whereby they have the right of first refusal, or the first claim on these batteries whenever they come into commercial production a few years down the road. This is speculative investment is pre revenue, you know, they don’t have a workable cell right now. The technology has to be commercialized and scaled. So you know, this is one of my speculative riskier investments. But you know, given the carnage we’ve seen in the stock over the last 12 months or so 15 months or so, I think that if they do pull it off, then this is likely to be a very sizable business, or 10 years from now, I wouldn’t be surprised if this stock becomes a 10 bagger over the next 10 years, if they get the technology to market and if they can scale. And I actually did some due diligence on this before investing. And I heard some comments from the inventor of lithium ion batteries. I can’t remember his name is a British guy. He won the Nobel Prize a few years ago. And he himself acknowledged that the data he has seen from quantum scape is the is by far the best database ever seen in solid state. And he thinks that this technology is viable. And then it’s only a question of time before quantum scape can actually commercially manufactured this at scale, and power, hopefully a lot of other car companies, which are going to be coming up with EVs you know, over the next few years. And they’re also going to get into battery energy storage. So they’re going to provide batteries for energy storage for utilities, which is going to be a pretty big business.
So you know, the car companies are exciting, you know, Tesla’s and stuff. If you are a shareholder in this, you’ve done very well. But my concern with Tesla is that there’s so much competition now coming online, with EVs, you know, Mercedes, Porsche, all the German companies are coming with pretty spectacular models. And Tesla, you know, has been the clear leader, and I don’t think it’s lead will be disrupted over the next five to 10 years simply because when people think of EVs, they think of Tesla, you know, just like people used to think of apple and they thought of smartphones. But, you know, auto manufacturing auto, em is inherently a high capex, traditionally a cyclical business model with a lot of competition. And I think if you invest in quantum Skype or a battery maker, for example, then you know, that battery maker is effectively going to be providing the picks and shovels for the EV race, so whoever wants the battery will have to come to them and get one. So I think, according to me, anyway, that I think, you know, this is a safer way of playing the space, because you know, it’s not subject to competition. If they do crack the solid state lithium battery technology, then you know, they will have patents and stuff, they will be protected. It’s not only very easy for competitors to replicate what they’re doing. But again, as I caution you again, you know, this is a pre revenue speculative investment, it was only about 3% of my total portfolio. So you know, if it goes wrong, it’s not going to kill me financially. And coming back to the other one,
Simon Erickson 38:56
Really good board of directors, too, by the way on quantum state. JB Straubel from Tesla, one of the co founders of Tesla. John Doerr has some influence there. A really, really strong and he’s such a strong leadership team.
Puru Saxena 39:07
Yeah, it’s pretty good. Corporate Governance seems to be pretty strong board of directors, a strong shareholder list is pretty impressive. So they seem to have the potential to be able to deliver these batteries in two or three years down the road. And if they do succeed, then I think, you know, the stocks gonna be up 510 X over the next 10 years, which is why I’ve invested in this. And if they do succeed, I think Simon in the next 10 years, they will still be growing at a very rapid clip. So I think this is likely to be, you know, 1015 year investment for me at least 10 years. And I think this is a pretty decent way of investing in this energy, sort of clean energy, battery sort of space.
Turning to your other company, you mentioned Nu Holdings. This is a Latin American digital bank. So they are now competing with the big I see banks in Latin America. And the company was set up by a Colombian guy who’s pretty impressive resume. He used to work for Sequoia. And he is Colombian. And the company actually works at the moment operates in Brazil and a couple of other countries. And they are also now offering a lot of solutions to their customers in Latin America, from banking, to credit to investing and everything else. So it’s basically trying to be a one stop shop an app for all the financial needs for the customers. And because it is a digital bank, they don’t have any branches, their costs are lower. So they are able to, you know, offer better rates, interest rates, and so forth, to the customers on deposits, they are able to offer advantages. And the revenue growth rate is fantastic. If you look at the revenue growth of this business over the last one or two years, is very, very strong. And even the analyst estimates for this business going out four or five years are pretty remarkable. Wall Street analysts expect that this company will be compounding revenues at 30 40% for five years out, which is pretty remarkable. And after this wash out, we have seen the growth stocks, I felt that the valuation had become pretty reasonable. You know, it’s not reasonable if you compare it with the likes of JP Morgan, or Bank of America, because they don’t have any growth. But if you look at a growth trajectory and what they’re going after, I think this has the potential of being pretty good winner over the next four to five years, at least if they are able to execute which the numbers seem to suggest that they are succeeding.
Simon Erickson 41:41
Latin America is very quickly getting connected to high speed internet and like you said, a digital bank is a natural winner from that. I wanted to ask you about MercadoLibre, which is one of the the ecommerce providers in South America, Latin America, really, it’s one of the leaders, mostly doing business in Brazil, Argentina and Mexico. Puru, I think that you have a love hate relationship with this company. It’s either, you know, it’s one of your larger positions, or you kind of changed your opinion about it recently here. How do you feel about MercadoLibre? And what do you think about their niche that they’re carving out in Latin America right now?
Puru Saxena 42:13
When I first invested in Mercado Libre, or 10 years ago, you know, around 1011 years ago, and I’ve been a shareholder. And up until recently was one of my bigger positions. But then I looked at what’s going on in Latin America in terms of competition, and you know, see limited going in there. And ecommerce is not really the big growth segment for Mercado Libre, now it’s payments and fintech and competition is increasing, as you know, in Latin America. And if you look at you know, the forward estimates, which are pay close attention to for revenue growth, so this company, analysts are expecting revenue growth to come down below 30% year over year, in a couple of years. And for me, that is usually the time when I exit because I don’t want to be holding the bag when the revenue growth goes from 70 or 80%, or 30, or 40%, and then down to under 30%, in two years from now, because that’s when these growth companies get absolutely clobbered. And for me, as an investor, you know, I try and getting early in these companies early on in the S curve early on in the cycle. So I can, you know, pretty much relaxed for the next four or five years, and just, you know, enjoy the group the effects of compounding. And I think Mercado Libre has become a mature business. Now, you know, the wrong rate is pretty large already. If there are any wrong rate, and it may still want to do well, but I think it’s not going to grow at over 30% In three, four years, which is why sold out and moved on to the new holdings, because new as I said, is likely to compound at 30 40% plus over the next four to five years. Yeah, you mentioned I don’t dislike Mercado Libre. I just think, you know, it’s matured already. And it’s not really suitable for my type of investing, because I try and investing in the really high growth space.
Simon Erickson 43:56
Sure. And you mentioned competition, right? Shopee setting up shop in, in Brazil is Sea Limited, I believe based in Singapore, if I’m not incorrect, Southeast Asian company, and kind of you know, we’re trying to geographically expand its ecommerce presence. Puru, I know that you’re in Hong Kong. That’s why it’s dark out here in Houston. But it’s very nice and bright in the morning for you over there. Can you tell me a little bit about Southeast Asia right now? I I know that there were very kind of restrictions for COVID. And that shut down a lot of the economy in several countries. But how are things over there is a different than than kind of the perspective we have for the economy in the United States. And then also, are there any Southeast Asian companies, tech companies or any companies that you’re kind of interested in right now?
Puru Saxena 44:38
Well, we’ve had the toughest COVID restrictions in the world and Southeast Asia and Hong Kong has been especially hard because Hong Kong has been following China’s COVID Zero policy. Which means that we’ve had some really strict travel restrictions quarantine one week quarantine for all returning residents and tourists into Hong Kong, this was three weeks several months ago. So it’s coming down. But, you know, COVID is still impacting the rules are impacting the way of life here in China has been pursuing the zero COVID policy, and their economy has basically slowed down significantly because of that. And because the vaccination rates have been pretty slow, in this part of the world, that’s why I think the Asian countries have been pretty slow to reopen. And I think, you know, reopening will happen, perhaps towards the end of this year, early next year, but it’s been quite difficult and challenging for residents in Hong Kong, because you I mean, most people haven’t been able to travel and leave the small city in two and a half years now. There’s a lot of uproar against the government’s policy of being so strict against COVID. But you know, the government is doing whatever it needs to do. And hopefully, things are now on the way up, and things are going to gradually reopen. Coming back to the second part of your question. I mean, see, Ltd was a pretty interesting business. And, you know, I have also been watching grab, which is the ride hailing business, from Singapore also, which looks pretty decent. But again, you know, I’m not really sure at this moment about their profitability and margin profile. So I’m just watching it from the sidelines. Apart from that, you know, all my other investments right now are either in the US or Latin America or Europe, I don’t really have any direct exposure to Asian companies at this point in time.
Simon Erickson 46:37
And how about investors in Southeast Asia, and you’ve got a lot of purchasing power out in that region of the world right now? People are buying more stocks are getting more interested in investing? Is it kind of a Silicon Valley, you know, go after the tech companies that they’re interested in? Do they like dividends? How do investors think about the stock market in Southeast Asia?
Puru Saxena 46:55
I think depends on like anywhere else in the world. The older generation wants the blue chips, dividends, and income and stuff like that. Some investors prefer innovation, the growth side of things, is pretty much, you know, a pretty individual choice is not really one sort of brush stroke for everybody, it comes down to what people are looking for in terms of their investments and where they are in the lifestyle.
Simon Erickson 47:23
Just two more questions for you, Puru. I’m really thankful for your time here today. But my first one of those is, is position sizing, right? You mentioned earlier diversification, is it 15 to 20 companies after that diversification, because you’re just you know, getting rid of your returns. But what’s a large position size for you? How long will you let a company run before you pull it back in again?
Puru Saxena 47:43
I mean, normally, Simon for high conviction company, I mean, you know, invest six 7% At the outset. But if the, if the position keeps increasing, and everything is fine, I don’t necessarily trim it. Unless we had, you know, we have like a crazy mania like we did in 2020 21, when stocks were going up 4x 5x 6x In a year, I mean, that has never ever been sustainable in the history of investing. That was a clear bubble. And that’s why, you know, I was selling out my shares, when they were doubling, tripling and getting out and a lot of people on Twitter was No, he’s not an investor, he’s a trader, well, it’s not really a question of being an investor, or a trader, if someone was gonna give me years of returns on a platter, in three months, I’m not gonna, you know, sit by and say, Oh, actually, I’m not gonna take my profits, because I’m an investor, not a trader. And you know, all of those companies are down 70, or 80%. So, if the business is doing well, and if we don’t have any sort of excesses of mania in the stock market, where the valuations have become so unhinged from the business reality, I don’t usually trim my positions at all. It’s only when the excesses become so obvious to me and glaringly obvious, where I know the future returns are going to be poor. And there’s not much upside left from these companies. In those cases, I may actually get out completely or, you know, during my position by 40 50%. But those instances are rare because stocks generally don’t work for 5x ammonia.
Simon Erickson 49:08
Very true. And my last one prove is is about hedging. You know, this is something that I consider you to be very, very skilled at. I know a lot of people ask you about this all the time. It’s very complex. I don’t think anybody could do it as well as you do. But for anyone that does want to kind of minimize downside. Certainly right now. That’s, that’s a topic is hedging downside risk, and in a bear market? Are there any practical words of advice you could give for investors on how to hedge that isn’t extremely complex, as I know that you are typically doing?
Puru Saxena 49:38
I mean, it’s not very difficult Simon, all you need to do is you know, find an ETF or index futures, which pretty much correlate with the holdings in your portfolio. So for an investor who’s invested in the high growth, innovation space, they may sell short arc ETF which is basically similar in its core deposition, which is what I do. So if I want to hedge my exposure long exposure, I sell short a RK K, which is the equivalent. So if I’m long say $100 worth of shares, I will say in short $100 of x, so the market goes down, my portfolio goes down 5%. So 100 becomes 95. My short also go, I mean goes down, but I’m short, the ark, so I’m making money. So it basically keeps me pretty much even, you know, it’s not a perfect hedge, but it keeps me pretty stable during unfavorable market conditions. And I’m not always aged I hedge only during downtrend not during uptrend, so when AR thinking is trending higher, then I don’t hedge my portfolio though, when Al Qaeda is trending lower, that’s when I sell short arc and hedge my portfolio. So in other instances, I may also sell short, NASDAQ index futures if I’m particularly negative about the near term outlook. But anybody can do this, you know, it doesn’t require a degree in engineering or anything like that. All you need to do is look at moving averages, you can have any medium term moving average, so a 50 day or a 70 day or 100 day 150 day. And if you want to keep things really simple, you can basically sell short, your corresponding ETF which is highly correlated to your holdings when the ETF or the futures go below that moving average. And then when the ETF goes back above that moving average, you get rid of the hedge. So as long as price is trending below the moving average of your choice, you are hedged. And when the price goes above the moving average, which means the uptrend has resumed, you buy back the ETF or the index that you actually sold short, and then you are exposed to market risk, you’re taking a market. So by hedging, all I’m trying to do is, during downturns, when the path of least resistance is downwards, I am trying to basically get myself out of the market by being market neutral. And I’m removing the hedge when that ETF goes above the moving average, I am trying to participate in the uptrend, which is what every investor is trying to do at the end of the day, you will try and minimize the downside. And you’ll maximize the upside. So I mean, hygiene has worked pretty well for me in this downturn, it hasn’t done amazingly well. But you know, if the typical drawdown in the investor’s portfolio, this year in the gold space is maybe 40 50%. My portfolio is down perhaps 15%, one, five, so it hasn’t been a perfect hedge, but he’s done his job, you know, as well as one would have hoped. And that’s why I hedge I mean, I don’t do it, because I like the complication, I just do it because it just allows me to sleep well, when the market is trending lower, whatever the reason might be, whether it’s the Fed, whether it’s a war, or pandemic, it doesn’t really matter. Whenever the price, you know, goes below the moving average, I hedge and remove the essentials, you know, purely objective is not, you know, subjective or based on my opinion or anything like that. I just follow price and the trends in the market to hedge or not hedge. It’s as simple as that. It’s not complicated.
Simon Erickson 53:14
But it’s objective. And and it’s methodical, I think you’ve done very well, Puru. We chatted about quite a bit here today, you know, we’re kind of winding down. We talked about interest rates, we talked about inflation, we talked about growth, style investing, we talked about Latin America, we talked about hedging, I guess to sum all of this up together, do you have any kind of thoughts for investors that might be watching this podcast or listening to this podcast? What’s on the horizon for 2022? It sounds like we’ve got some challenges, we’ve certainly got the American economy is got some things to keep itself busy this year, but any any words of wisdom for for investors and what to expect for the upcoming year here?
Puru Saxena 53:50
My assessment is that, you know, the bulk of the carnage Simon in the hydro space is now behind us. And even in the indices, I suspect, you know, we may go down another 10% or so. But I don’t think we’re going to see a 50% bear market in the indices, like we saw in 2000 2002. And also in the global financial crisis, and oh, 809 I don’t think that’s on the cards. I mean, I may be wrong, things can change pretty quickly if there was a policy error. But the way things are right now, I think, you know, we may see a little bit more selling the indices, grow stocks, in my opinion, are pretty much, you know, done. They think they’ve already corrected all the accesses. And then some. So valuations have become a much more reasonable today. And over the next few weeks, or maybe in the next couple of months as the economy slows down pretty rapidly and inflation cools I believe we are going to see a pause from the Federal Reserve. And as soon as the Fed says right, you know, we are pausing now. You know, we’re going to take a wait and see approach, risk assets are going to take off so I think The second half of this year is likely to be a lot better than the first half. And as soon as we have a policy pause or a policy shift on the Fed, I think these beaten down long duration risk assets are going to really take off over the next 12 to 15 months or so. So I think if you are a shareholder in these high growth, tech stocks, which have been absolutely pummeled, over the last few months, I think the rest of the world today is a lot more favorable than it was late last year, because prices were three times higher, you know, in the investment business, your risk is directly proportional to the price, you know, the lower the price, the lower the risk, and vice versa, you know, the higher multiples, especially when you get to 3040 50 times revenue. So the range historically never ended. Well, today, you know, you can bind to the same companies, I’m at 1012 times a year and revenue seven or eight. In some cases, you know, Twilio is trading in single digits 2022 revenue multiple, which is absurd. October’s down, can even handle the other growth stocks in my portfolio, they’re really high growth, promising companies like Sentinel, one GitLab, confluent, all these companies are now trading at what I consider reasonable valuations. So I think, you know, as a shareholder, I’m hoping that over the next four or five years, I will be able to capture all if not, most, if not all, the business growth from these companies, because I don’t really think that there’s going to be much more valuation compression in the next three or four years. But I may be wrong, you know.
Simon Erickson 56:39
That’s a perfect summary of where we stand and the US economy in the stock market right now. Again, Puru Saxena is an individual investor, a retired money manager. It’s really a pleasure having you on the podcast here today, Puru. Thanks very much for joining us.
Puru Saxena 56:52
Thank you very much Simon it was a pleasure to talk to you.
Simon Erickson 56:54
Thanks everybody for tuning into this edition of our 7investing podcast. We are here to empower you to invest in your future. We are 7investing.
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