Why I'm Buying Stocks in 2022: Innovation Ultimately Wins - 7investing 7investing
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Why I’m Buying Stocks in 2022: Innovation Ultimately Wins

The stock market has been undergoing some extreme volatility. 7investing CEO Simon Erickson publishes this special CEO letter to share his thoughts about inflation, valuation, and why right now is the time to be investing in the stock market.

February 22, 2022

The stock market has been plagued by volatility in 2022. And it’s getting harder and harder to look away.

MSN has reported the Nasdaq just finished the second-worst January of its entire existence. The Wall Street Journal reminds us that institutional analysts are cutting back their forecasts for stocks in 2022. Elon Musk is now tweeting that a recession looms on the horizon. And even Punxsutawney Phil saw his shadow, meaning we’re due for even more chilly winter weather.

Moreso, the fundamental reasons for concern appear to be valid and legitimate.

Inflation is already taking hold. The Labor Department reported the Consumer Price Index spiked 7.5% in January, which is the fastest annual pace of inflation we’ve seen in 40 years. The Social Security Administration recently issued a 5.9% increase in its Cost of Living Adjustment that impacts the benefits paid by Social Security plans. That, also, was the fastest year-over-year increase we’ve seen in four decades.

There’s also the issue of rising interest rates. The Fed has suppressed interest rates for 14 years, but money can’t remain this cheap forever. Rising rates could constrict borrowing and growth, meaning our hot economy might be cooling down to a more lukewarm state.

And if all of that wasn’t enough, now there’s an international incident. Investors are worried that Russia’s advances on Ukraine could lead to a prolonged military conflict and global financial instability.

Sell Everything and Head for the Hills?

The Year of the Tiger has already been exposing its claws. And it’s quite understandable if all of this has been taking a toll on your investing morale.

Suffering losses in the market stings our psyche twice as hard as the joy we experience from building gains. And I’ve heard more than a few investors suggest they’re just throwing in the towel, selling all of their stocks in order to load up on gold, ammunition, and beef jerky (or at least sentiments that are similar).

I’m not convinced sticking our head in the sand right now is prudent advice. I’ll even go a step further and say that I am personally buying stocks right now. In fact, I’ve done more buying in my personal portfolio from December through February than at any other three-month stint of the past three years.

How can that be? Haven’t I been reading the news headlines? Haven’t I seen the tweets and the Pennsylvania rodent prognostications?

Why Long-Term Investing Works (Even During Selloffs)

Yes, I have. But let’s first talk about the numbers.

Every few years, the Boston Consulting Group takes an objective look at long-term equity returns of the market’s best performers. They further break those returns down into individual components, to determine what factors are most-correlated to any individual stock’s returns.

BCG came up with some important conclusions. Profitable revenue growth is the primary driver of a stock’s long-term performance. For the market’s very best performers over long time periods, revenue accounts for an incredible 50% to 70% of the value creation — which is tied to total shareholder return.

That means that long-term investors can tune out the short-term noise. Stop fretting about the inflation, the rising interest rates, the recession fears, the military standoffs, or the cold weather.

The news and the seasons change every year. But your long-term returns are much more highly correlated to your ability to find companies with sustainable top-line growth. And then having the conviction to hold on to them for a decade.

The Valuation Debate

Next, let’s talk about valuations.

The financial media has taken an interest in chatting about the stock market’s recent bubbly valuation multiples. Softer language has suggested that 2021’s tech stock valuations were overly-inflated and are due for a regression back to the mean. A harsher tone has declared the market was experiencing a bubble that necessarily needed to be burst.

Whichever stance you prefer and whichever numbers you use to support it, one thing is clear. The internet and cloud computing have completely changed the tech landscape, and the market has needed to evolve in how it values tech companies.

Famous venture capitalist Bill Gurley famously wrote a decade ago about The 10X Revenue Club. He suggested that internet-native companies with sustainable, recurring revenue could now justifiably have stocks priced at ten times their trailing sales.

Ten times sales sounded “expensive” in 2011. But the market took things a step further.

Cloud computing – where Amazon (Nasdaq: AMZN), Microsoft (Nasdaq: MSFT), or others built the infrastructure to host your cloud-based apps – drove up the profit margins of software companies even higher. This step-change of profitability allowed the stocks of SaaS companies to be priced at 20x or 30x trailing sales. Investors gained confidence in the 90%+ gross margins and 90%+ retention rates and were willing to pay higher valuations for them.

We’ve seen a gradual increase in tech stock valuation multiples for the past decade. But this last year has been a hard reset of previous assumptions.

Right now, the market has no idea how it wants to value its fast-growing tech companies.

A case in point is Upstart Holdings (Nasdaq: UPST). Upstart knocked it out of the park in its recently-reported earnings. The stock shot up 30%. There were hundreds of articles praising and commending its incredible results.

But let’s zoom out a bit, and recognize this short-term win is still surrounded by a sea of uncertainty. Upstart’s Price-to-Sales multiple has been all over the map – ranging from 13x to 60x during this past year. Investors have violently shifted from euphoria to paranoia and all points in between.

Yet Upstart the business is keeping its head down and is focused on building something incredible. It is growing revenue at 250% per year and is signing partnerships left-and-right with new financial institutions.

The valuation multiples will bounce around from month-to-month and year-to-year. But let profitable revenue growth remain as the metric most worthy of your attention. Growth will trump valuation over long periods of time.

The 7investing Key Takeaway

My former colleague and neighbor Morgan Housel pointed out that Napoleon once said “a genius is the man who can do the average thing when everyone else around him is losing his mind.”

History doesn’t repeat itself, but it certainly does rhyme. There were plenty of terrified investors during 2001’s dotcom implosion, during 2008’s great recession, and now during 2022’s tech stock selloff.

Yet successful long-term investors have the unique gift of persistence. We have an ability to brush off the past, to tune out the noise, and to look at fundamentals to evaluate our forward-looking returns. The stock market doesn’t care about your cost basis or where you came from before. It only cares about where you’re going from this point on.

We’re going through some tough sledding amidst the winter weather. If you can handle the turbulence and focus on the steering, you’ll end up navigating to your best long-term destination.

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