Disclaimer: The following article is not investment advice. It simply only states my opinions.
Twitter is an interesting company to observe. For a long time I have had very mixed feelings about this social media platform. It is very easy to write it off and there are many reasons to it; chiefly one could argue that it is a toxic platform and has a negative effect on one’s mental health. From an investment point of view, there are additional reasons to be cautious. The company currently doesn’t have strong fundamentals and is not a cash generating machine in the same way that say Meta Platforms or Alphabet are. Even with its current share price more than 50% down from it’s $80+ high reached in February last year, it is a highly speculative stock.
However, when I look at Twitter objectively, I do think it’s model as a social media company, specifically how it’s designed, is unique and I would probably argue that Twitter is one of the most effective and powerful social media platforms to use if you want to get your voice or message heard instantly and to make some kind of noise. Traditional newspapers and journals will always have their place and there will always be a demand for quality content, yet for writers and journalists, Twitter is a much more powerful platform to get one’s message across than solely via a newspaper or blog. Twitter is the ultimate vehicle for someone not only to have their voice heard but to have it amplified in an exponential way.
The other thing that is interesting about Twitter is that almost every public figure uses it. Most people that matter and have something important to say are on it. Almost every person in government has a Twitter account. Almost every writer and journalist also has a Twitter account. The bottom line is that nearly every person who is outspoken is on this platform. For me, this is a very important sign and it reveals to me how powerful and disruptive this particular platform is.
Often I will value a company on its fundamentals in order to see what the company’s margin of safety is. Valuing something like Twitter is much more of an art. It requires truly understanding the platform, specifically it’s power and how it will develop as the internet continues to evolve. The fact that so many public figures, businesses and entities use the platform tells me that this platform clearly provides a lot of value and has very strong network effects.
Meta Platforms, which comprises of Facebook, Instagram and WhatsApp, currently has a market cap of just under a trillion dollars. Alphabet, the parent company for Google and YouTube, has a market cap of nearly $1.8tn. Twitter, on the other hand, has a market cap of just under $30bn. Some people may say that for a company that lacks the cashflow generation of Meta or Alphabet, a $30bn market cap is still very high. And they are not wrong. However, what if Twitter were really able to harness it’s power and become a huge cash flow machine? It is often said that it is important that a company still has its founder/s on board to steer the ship and provide a unique vision of how the company should be developing and operating. However, in the case of Twitter it is not unreasonable to say that it’s founder Jack Dorsey may not be the right person to really take the company to even greater heights. He was instrumental in the beginning phases of the company’s growth. Twitter still needs someone who is visionary and completely understands the company to take it forward, yet it also needs a mature, resilient and pragmatic leader and one who is able to realise and, more importantly, monetise all the company’s untapped potential.
Recently, Dorsey stepped down as CEO of Twitter. He was replaced by Parag Agrawal, who has worked at Twitter as software engineer since 2011. In 2017, he became the chief technology officer of the company before replacing Dorsey as the CEO in November last year. I could be wrong, but I sense that Agrawal will have a lot of success in cleaning up the image of the company and improving its credibility by cracking down hard on fake accounts and accounts where individuals and entities spread disinformation. I also think Agrawal will be serious in establishing ways to further monetise the platform and increase its user growth which has been sluggish.
Anyone who has studied the market performance of Twitter stock since it first IPO’d back in 2013 will know that the stock hasn’t really punched above its weight. Yet I think even if user growth continues to be a challenge, at least in the short run, I think the company has the potential to vastly increase its revenue. In Q3 21, the company generated $1.28bn in total revenue. I think there is the potential for the company to at least quadruple it’s total revenues from that point whilst still maintaining a healthy sized gross profit margin and keeping other costs like R&D, sales and marketing, and administrative costs at a reasonable level. If the company successfully pulls all this off, I would not be surprised if it grew into a market cap quite a few multiples from its current market cap of just under $30bn. I think in the next five to eight years, it is entirely feasible for the company to command a valuation of at least $150-200bn provided it makes big changes and succeeds.
The month of January has been a rather volatile one for financial markets. In particular, in the USA, where the markets over there are heavy with technology companies with enormous market valuations; a few of these companies, including Apple, Microsoft, Amazon and Alphabet, currently have market valuations in the trillions of dollars. Already back in 2019, when the NASDAQ index, which includes those megacap tech names, was hovering around 8000 points I wrote an article where I expressed my concerns that I thought the index was looking very frothy. In 2009, toward the end of the Financial Crisis, the NASDAQ was below 1500 points. In a decade it had increased over five times in value. At the height of the 1999-2000 dotcom bubble, the NASDAQ hit an at the time all-time high of over 5000 points. It would be another fifteen years before the NASDAQ would breach 5000 points again.
Back in 2019, some analysts expressed concerns about the heady valuation of several US tech stocks and that with the NASDAQ trading at over 8000 points, it was ripe for a correction. Towards the end of February the following year, those analysts got their wish when global markets began to dramatically correct in response to the outbreak of the COVID-19 pandemic. Investors began to panic and growth/tech heavy indices like the NASDAQ began to drop in value. In January of 2020, the NASDAQ had reach an at the time all time high of over 9000 points. By March of that year, it was trading in the 6000s.
Although, those who had been predicting a crash the previous year may have felt vindicated for a brief moment, very few could have foreseen the response by the Federal Reserve (Fed) and how it would promptly intervene with a dramatic increase in the US money supply and an enormous expansion of the Fed’s balance sheet. As a consequence, the NASDAQ duly rebounded from March 2020 and would embark on a mind-blowing run lasting many months. By November 2021, the NASDAQ hit a fresh all time high of over 16,000 points; more than doubling from it’s mid March 2020 level and almost doubling from it’s 8000+ level from back in 2019 when I wrote my article expressing concerns about it’s then heady valuation.
When the pandemic began to sink in and the Fed reacted via it’s huge financial stimulus programme essentially flooding the US economy with lots of new money, investors began to favour a certain group of stocks that became all the rage as they thought would thrive in this new pandemic environment. Governments around the world imposed multi-month long lockdowns and for many people at the time, there was a feeling that this pandemic would never end. Thus investors turned to technology stocks; stocks investors concluded would benefit the most from a stay-at-home environment. These stocks, already commanding rich valuations before the start of the pandemic, began to get even more crazy. At the same time, boring old school blue chip value stocks began to sell off even more. The travel and hospitality sector suffered greatly by global lockdowns and travel restrictions. The oil and gas industry too had a tough time with the price of a barrel of crude oil briefly entering negative territory. Sentiment in both those two sectors was completely shot to pieces, whilst the technology sector was in full on mania mode. But it wasn’t just the big tech names like Microsoft, Apple and Alphabet that were doing well, a new crop of technology stocks that became darlings during the pandemic, such as Zoom and Peloton, went on an epic tear.
As 2020 turned to 2021, this madness showed no signs of abating. In fact it all reached a brand new level of craziness. With many in the US receiving their COVID-19 financial stimulus cheques, which were originally intended to alleviate the financial burdens of those affected by the pandemic, a large portion of those cheques were used for speculation in the markets. A handful of stocks began to command valuations that just simply made no sense. One example was the struggling video game retailer, Gamestop. At the time it was one of the most heavily shorted stocks in the country. Until a group of investors from the social media site Reddit began to drive up the price of the stock massively with the intention of sticking it to the hedge funds who had large short positions on the stock. In the month of January 2021, Gamestop stock rocketed in value from just under $20 a share to over $300 before crashing to around $40 the following month. Many naïve and inexperienced investors got suckered into this micro rally and got badly burnt on the way down. It didn’t matter that this was fundamentally a worthless stock with no credibility.
In addition to those shenanigans, the beginning of 2021 saw another heady bull market emerging in the cryptocurrencies space with the price of Bitcoin entering the new year on a new high. But the increase in the price of Bitcoin during this period paled in comparison to other even more speculative areas of the crypto space. One of these was the booming popularity of NFTs or Non Fungible Tokens. These tokens are digital files that can be bought and sold with certain cryptocurrencies. During the first few months of 2021 this area of the market reached a complete fever pitch with a some individual NFTs even fetching millions of dollars. An NFT by an artist called Beeple fetched over $60m – an eyewatering amount of money; the kind of money that would exceed even the kind of money fetched for some of the best known and highly prized paintings by the most famous old masters of the ages.
Yet by the end of the year, cracks were already starting to appear. The last 13 years since the Financial Crisis has been dominated by a period of extremely loose monetary policy. It is no surprise that such a long period of rock bottom interest rates has led to one of the longest and most spectacular bull markets in history. And because of this it feels artificial. Wages have not gone up anywhere near the same level during this time period. In fact they have been rather stagnant. This has resulted in the USA experiencing a level of inequality not last seen since the 1920s. Or more specifically, the end of the 1920s. The so called Roaring Twenties ended with an epic stock market crash leading to a brutal multi-year long Depression. The Dow Jones Industrial Average (DJIA) hit a high of over 6000 points in August 1929, at the apex of the 1920s stock market bubble. In December 1920, the DJIA was just over 1000 points. When the this near decade long bubble burst during the last few months of 1929, the DJIA continued to crumble over the next few years during the Depression reaching just 910 points in May 1932. This was less than the low breached by the DJIA in 1920. In a little under a few years, all the gains the DJIA had accumulated had been more than wiped out. The next time the DJIA went over 6000 points was in 1959; a staggering thirty years since that level was last reached.
Many investors and analysts like to compare the current stock market boom, especially over the last few years, with the dotcom boom of the late 1990s. Whilst there are many similarities, namely with all the exuberant valuations of many tech stocks with poor fundamentals, I find the stock market boom of the Roaring Twenties a better comparison. This is especially true when measuring inequality in the USA over a 100-120 period. The incredibly loose monetary policy over the last 13 years had made this current bubble not only one of the largest in financial history, but also one of the most dangerous. Total US government debt before the 2008 Financial Crisis was already very high. However, between Q1 2008 and Q3 2021, total US government debt has near trippled from $9.4tn to $28.4tn. This is an astonishing increase for such a comparatively brief time period in US history.
During the last year, inflation has began to rear its ugly head. Some have been taken by surprise by this inflation, but I am anything but surprised. This was a long time coming. It is amazing that it has taken so long to appear. Of course, the super lax monetary policy of the last 13 years has seen incredible asset price inflation, but not so much consumer price inflation. But this all began to change last year when the US rate of inflation hit 6.8%, it’s highest level since 1982. The Federal Reserve now finds itself in a difficult position as even just a very modest raise in interest rates can have reverberating effects on the US stock market and economy as a whole. Over a decade of rock bottom interests in the US has, as already stated, almost tripled the total amount of US government debt and created a stock market bubble of absolutely epic proportions. In November 2008, the NASDAQ was trading below 1500 points. In November 2021, exactly 13 years later, the NASDAQ traded above 16,000 points. This is a more than ten-fold increase of absolutely dazzling asset price inflation. So much is now at stake, yet this bull market has never looked more fragile.
As of now, US interest rates still stand at zero. However, the last month has seen the NASDAQ fall quite sharply in value. By the end of last week, the NASDAQ was trading at 13770 points. Whilst this is a not inconsiderable drop from the 16,000 points plus high of last November, it is still more than double the low it reached during the brief stock market correction of February-April 2020. Moreover, it is still more than 9 times the value that it was in November 2008. What has been interesting is that the NASDAQ falls of the last month occurred before any interest rate hikes. The Fed intends to raise interest rates in tiny increments. However, the real question here is how much of a problem will inflation continue to be? This is where the Fed under Jerome Powell has really been asleep at the wheel completely underestimating the long term consequences of a decade plus of uber low interest rates, quantitative easing and cheap and easy money. Some economists make forecasts as if their projections will come into fruition with complete certainty. Yet the truth is no one can predict the future, regardless of one’s credentials and brain power. Not so long ago, the prevailing narrative was that inflation would be ‘transitory’. I didn’t and still today don’t agree with this narrative. I also don’t believe that the sole root of this inflation is the supply side shocks induced by COVID-19. As I have already mentioned, I am simply just surprised that, after over a decade of very loose monetary policy, it has taken so long to rear it’s ugly head.
What can really cause the current bubble to unwind much more is precisely if inflation continues to be a much longer term headache. The Fed may want to only slowly increase rates by small amounts, but what happens if inflation were to get worse and go into double digits? If inflation were to get out of control, I suspect that the Fed would have to increase interest rates by much more than it originally intended. This would bring an abrupt end to the cheap money era that has prevailed for so long. The biggest winners of this era have been growth stocks – particularly those in the technology sector. Invariably, companies with weak fundamentals would be trading on gargantuan market valuations. These companies would not be making any money and would be burning through cash. Yet often investors would be attracted to them by the story they projected rather than doing a deep dive into their financial statements. The cheap money era has been particularly favourable for startup companies not even publicly listed yet. It wouldn’t matter whether or not these companies were making any money. With so much cheap money sloshing about Venture Capitalist funds would throw ever more money towards them. In such an environment valuations do not seem to matter. And this is why I find this current rise in inflation very interesting as there is every chance that it will force the Fed to raise interest rates by much more than it was expecting thus bringing an end to this party. All of a sudden valuations will actually start to matter and all those companies that had heady valuations without ever making a profit will be in real trouble.
Already some of the darling stocks of the pandemic have had drawdowns of more than 50%. The video teleconferencing platform Zoom, which became increasingly popular as the pandemic unfolded, saw it’s stock motor from $76 at the beginning of January 2020 to a peak of over $550 in November of that year. Last week the stock traded below $140. The other darling of the pandemic, the exercise equipment and media company Peloton, saw it’s stock increase from around $30 at the very start of 2020 to over $160 just before the end of that year. Today it currently trades at $25 more than wiping out it’s 2020 gains.
The larger and more robust tech titans like Apple, Microsoft and Amazon have also experienced drops during the last month but they have overall still managed to hold on to their mega valuations. Apple recently hit a market cap of $3tn making it the most valuable company by market cap on the planet. At the beginning of the year it traded at over $180. Today, it’s trading at $170 with a market cap of nearly $2.8tn. It was only in 2018, when Apple became the first company to reach a $1tn market cap. In just a few years it has trebled its market cap. This is simply amazing growth for such a juggernaut of a company. Yet Apple is not cut from the same cloth of the more speculative tech stocks. Where Apple substantially differs is that it is a colossal cash generating machine of a company. Apple has a very rock solid moat and phenomenal pricing power. Even with at a near $2.8tn market cap, it currently trades on a not unreasonable PE of 28. Apple and the other tech stocks with solid cashflows that don’t need to raise money, will likely fare much better, despite their rich market caps, than the more fundamentally shaky tech stocks that still don’t generate adequate cash flows. However, Apple is not completely immune from any future shocks. I suspect that a continued rise in inflation will not only put a bigger strain on the finances of consumers, it will also further inflate the prices of important raw materials that are integral to Apple products. There could also be unforeseen future problems in China that severely affect the manufacturing capacity of Apple products.
Over the last 13 years whenever there has been a sharp correction in US equity markets it wouldn’t last for very long. The Fed would promptly intervene by pumping liquidity and thus causing the markets to sharply recover all it’s lost gains. The bull market would continue to just hit new highs. It is because of this that the USA still hasn’t experienced a prolonged bear market since the last Financial Crisis. For some time investors have simply taken it for granted that the Fed would just simply come to the rescue whenever there was any major market turbulence and stocks would duly rebound. But what if this time, the Fed finds that it has limited options to calm a plunging stock market? Higher than predicted inflation will almost certainly force the Fed to substantially increase interest rates. Money at much higher rates will cease to be cheap and the market, like a raging drug addict, will find that it is unable to get it’s usual fix of central bank stimulus. I suspect this will all have the affect of leading to markets being volatile and plunging to bigger lows over a much larger time frame leading to a bear market of many months or even years.
Don’t think the tech heavy US markets could experience a painful multi-year long bear market? Well, think again. It took almost 30 years for the Dow Jones Industrial Average to reach it’s all time high reached at the height of the Roaring Twenties stock market boom. When the dotcom bubble of the late 1990s burst in 2000, it took the NASDAQ 15 years to reach it’s all time high reached at the height of that bubble. Some stock market indices never again reach their all time high. Japan in the 1980s experienced an absolutely wild stock market and real estate boom. At the very end of that decade, the Nikkei 225, was trading at an all time high at over 38,000 points. Over the next year in 1990, the Nikkei 225 almost halved in value and over the next several years drifted downwards eventually bottoming below 8,000 points in 2003. The Nikkei has since recovered and as of today trades at around 27,000 points. Yet this is still short of it’s all time high it reached more than thirty years ago.
Tesla is arguably the most divisive and one of the most high profile and hyped stocks in the world today. I have written about Elon Musk and his companies in previous blog posts over the last few years . During that time I was in awe of the projects he was working on. How he has been able to take Tesla from a niche electric car company and scale it to a massive mainstream global company is beyond impressive. Ditto his progress with his other company, Space Exploration Technologies. Although the space industry is still a very nascent industry, he has arguably done more than any other commercial entrepreneur to create the infrastructure to make it possible for space exploration to potentially become a thriving and fast growing industry.
Since Tesla first became a public company, it has always attracted a lot of attention. On one side, there are millions of Tesla supporters and fanatics who worship Elon Musk almost elevating him to the status of a powerful religious figure. In their eyes he and his companies can do no wrong. Then on the other side, you have a group of sceptics. The most extreme contingent of this group are full-on haters who intensely dislike Musk and everything he stands for. Where the most passionate supporters see Musk and his companies as the future – the most powerful narrative being that some see him as the man who will pave the way to make the world an interplanetary species – his most damning critics see him as a fraud and a charlatan – an emperor with no clothes. The most fervent haters are the yang to the yin represented by the most fervent fanboys. However, the more thoughtful doubters are not cut from the same cloth. They draw their own conclusions on Musk and his companies based on facts and rigorous research.
Back in December 2019, I wrote a post on my predictions for the coming decade . One of my predictions was that I stated that it may be unwise to bet against Musk and his companies – basically echoing Peter Thiel’s mantra of “Don’t bet against Elon”. Since I made this prediction the share price of Tesla has been on an epic tear. Although I could see a lot of potential for the share price of Tesla to do well – merely on the prevailing sentiment alone. I could never in a million years have expected the share price to have gone absolutely parabolic in such a short space of time. Back when I made my prediction, the market cap of Tesla was around $50bn. Today, it is just over $1tn.
For the last decade or so, like many others, I had a lot of admiration for Musk and his companies. I was even in awe of him as I couldn’t think of another entrepreneur who was doing what he was doing and had the same breadth of vision as he had. However, today I have very mixed feelings. What has changed? I think in the past I was most definitely swayed by the narrative. But I don’t think it was just that. As I just said, who else is doing what he is doing? Nobody else has a pure EV and energy company on anywhere near the same scale as his. What’s more, no other entrepreneur has a commercial space exploration company at the same level of development as his.
I suppose any scepticism I had of Tesla back then was purely related to the company’s financial statements and how out of whack they were with it’s market cap. Yet, unlike the sceptics of the time, I reasoned to myself that Tesla was not only a high growth company, it was also more than simply just a company selling EVs. It was and had the potential to be much more than that and that at some point in the future it would eventually grow into it’s high market valuation. This was also along the same lines as the Scottish investment firm, Baillie Gifford, who are one of the earliest investors in the company and have seen their stake grow exponentially since then.
Many of the Tesla sceptics operate with the ticker symbol TSLAQ via Twitter. Whilst a section of this group may be hateful and spread lies and misinformation on Tesla, there are a good number who have legitimate concerns about the company based on facts. And I think it’s important that these are not swept under the carpet. One high profile example are those shared by the fund manager David Einhorn back in 2019. Einhorn is known for his bet against Lehman Brothers bank just before it collapsed during the 2008 Financial Crisis. It is easy to dismiss Einhorn today, especially since he (like others) had short positions on Tesla stock at the time and got badly burnt when the stock exploded in value in 2020. Musk also famously sent Einhorn a pair of “short shorts”.
However, I wouldn’t write Einhorn off so fast. One of his major criticisms of Tesla relates to it’s acquisition of Solar City back in 2016. Einhorn went as far as saying that Musk “knowingly orchestrated a significant fraud by arranging the $2.6 billion acquisition at a time when SolarCity was insolvent. Musk and his family had a huge conflict of interest, but rather than properly recusing himself, Musk initiated the transaction and drove the process.” Indeed, this acquisition was controversial. Solar City was a company founded in 2006 by brothers Peter and Lyndon Reve who are both cousins of Musk. Musk himself was the chairman of the company and instrumental in helping to found it. Solar City since it’s inception was, however, quite a cash intensive company. Although it was growing at a fast pace, it was also losing a large amount of money. For example, in Q1 of 2015, the company generated $67.4m in net revenue, yet made a loss of $146.9m with operating expenses alone being $147m. Back in Q1 of 2014 operating expenses were less than $90m . Often such losses are normal for a high growth company since it is often assumed that in the longer term the company may develop a sufficient moat as well as a level of scale and market leading position meaning that over time there is every possibility that it would be generating much higher revenues and solid net income profits. A low interest rate environment has also been very favourable for these kinds of companies since it means that money is cheap and thus it doesn’t matter if they are not making any net profits any time soon. However, in 2016 Solar City desperately needed a bridging loan of $200m  to avoid defaulting on it’s debt and it was struggling to raise money for it. It seemed that no one was prepared to lend Solar City the money. Failure to secure this loan would have likely resulted in the company going bankrupt. This would have had significant consequences for Musk and his companies. SpaceX owned 77% of the Solar City bonds  and if Solar City were to go bankrupt, this would have affected SpaceX in a huge way and possibly even it’s ability to continue as a going concern. It would have also been a huge financial blow for Musk since he personally owned over 22 million shares of Solar City stock worth nearly half a billion dollars . Thus, Einhorn, whether one may like it or not, is quite correct in his assessment that Musk committed fraud on a grand scale and that there was an enormous conflict of interest. Musk may have dressed the acquisition up as a takeover of a company aligned with Tesla’s own ambition’s as a clean energy company, when the truth is it was a bailout of his cousins’ struggling company not just to save his cousins’ skin but also his own and that of his companies.
The other glaring concern for me are the sheer number of lawsuits against Tesla. There are over 1000 lawsuits against the company of which 200 are in China alone . Aside from the Solar City case, perhaps one of the biggest and most unnecessary burdens on the company is Musk’s own erratic and unpredictable behaviour, which have led to lawsuits and fines. Perhaps, the most well known one is from back in August 2018, when Musk stated via Twitter that he was considering taking Tesla private and that he had ‘funding secured’. Not only did he not provide any evidence of having ‘funding secured’, he also violated federal securities laws with his tweet. The plain fact is that if any other CEO had done what Musk had done, they would have been fired on the spot and probably would have faced consequences of a far greater magnitude. I remember that time well and the whole furore that ensued. Yet, at the time I thought it was inconsequential in the grand scheme of things. My mindset was very much, ‘Ah, that’s just Elon being Elon. Fundamentally, he’s a genius and a visionary and this kind of behaviour is just part of his eccentricity.’ But I don’t know whether it is morally right to be so lenient on something so serious and to just shrug it off. This is especially true since this is not the first or the last time when Musk has behaved in an erratic and destructive way on his Twitter account. Sometimes, his tweets have been beyond the realms of bad taste. There is of course that well known incident from 2018 where he called a British diver who saved a group of young boys trapped in a flooded cave in Thailand a ‘pedo’. Then, rather more recently, he sent the following tweet earlier this month to Ron Wyden, a Democratic Senator from Oregon; “Why does ur pp look like u just came?” Wyden was critical of Musk’s decision to sell portions of his Tesla stock to pay taxes in accordance to a poll he proposed on Twitter. Wyden quite rightly stated that Musk paying tax, ”shouldn’t depend on the results of a Twitter poll.” . Just a few days ago on November 13th, US Senator Bernie Sanders tweeted, “We must demand that the extremely wealthy pay their fair share. Period.” Musk responded to Bernie’s tweet with, “I keep forgetting that you’re still alive”. In a perverse kind of way, I find a lot of this quite entertaining. The world of Twitter would most certainly be a duller place without Musk’s tweets. Yet the difference is that Musk is no ordinary Joe. He is currently the richest individual in the world due to the explosive rise of the share price of Tesla. It is also never wise to taunt or provoke prominent people in government positions, especially with that level of power. After all, even if you are the richest person in the world, it is ultimately the government that operates the switch, not you.
There have also been cases regarding the safety and shortcomings of Tesla’s vehicles . These have included battery fires. As early as 2012, there were leaked emails saying that Tesla had knowingly sold Model S vehicles that had design flaws in it’s batteries making them very vulnerable to catch fire. This has been a never ending issue and even involved the National Highway Traffic Safety Administration (NHTSA) intervening in 2014 and 2019. Even as recently as this year, Chinese regulators also stepped in after a number of customers in China reported and complained about the batteries in their Tesla vehicles catching fire. Furthermore, there have been reports of break failures, “whompy wheels” (where the suspension system of the vehicle breaks sometimes resulting in a wheel collapsing or falling off), and cases of sudden unintended acceleration. Perhaps the most high profile safety issue relates to Tesla’s Full Self Driving (FSD) software in it’s vehicles. This is controversial as it’s very misleading. The FSD software is anything but and requires drivers full supervision. However the fact that it is advertised as such is dangerous as it has resulted in multiple accidents where the drivers were under the misapprehension that they had full self driving software in their vehicles. Whether Tesla will ever develop true self driving software is another matter but by falsely selling products advertised in this way is not only misleading it also poses a serious risk to the drivers of it’s vehicles as well other drivers, cyclists and pedestrians.
I could go on but I think I’ll leave it at that. What is quite astonishing is that in spite of all these issues, millions of people continue to worship Elon Musk in an almost blind and blinkered way. On Twitter, he currently has over 60 million followers. When Peter Thiel says, “Don’t bet against Elon” he means don’t bet against a visionary a la Steve Jobs. And I continue to echo Thiel’s words too, but for different reasons this time. For me, betting against Musk implies betting against a universal chosen one with millions of fanatical and devoted fans. All the aforementioned issues and concerns don’t matter and have barely made a dent to his popularity. This is why for many years, short sellers, have lost staggering amounts of money betting against Tesla. And not all these short sellers are fools. Some of them like David Einhorn and Jim Chanos (who famously made a fortune betting against Enron) are highly respected and do tremendous amounts of fundamental analysis on the companies they focus on. They were both right in their analysis on Tesla, but what they forgot to account for was the sheer fandom and worshiping at the Temple of Musk. As a wise bulletin board poster once told me when commenting on the amount of money lost by Tesla short sellers; “Never bet against the great levitator”. Quite.
The economist John Maynard Keynes said it best with his immortal words about financial markets being able to stay irrational longer than one can stay solvent. I think it was Keynes who said those words yet it doesn’t matter. What matters is how important and powerful those words are. I personally think these are some of the most important words of advice for any investor whether they are a novice or seasoned. One may have complete confidence and conviction in a security they are investing in yet there is always the chance that things don’t go according to plan regardless of how much due diligence they may have done on it.
The Big Short is a well known book by Michael Lewis, which was later made into a successful film. The book is about an investor and fund manager named Michael Burry who places an enormous bet against subprime mortgage bonds. He was one of a small handful of investors who at the time discovered how rotten those bonds were and how they had the power to create an enormous financial crisis, which they eventually did in 2007-8. He placed his bet relatively early in around 2005. At the time, it was seen as a rather contrarian thing to do as the majority of people in the financial world were amazingly unaware of how toxic those bonds were.
Although Burry would eventually be vindicated and handsomely rewarded for his bet, I personally think that the way he went about it wasn’t so smart. To be clear, I am not for one moment knocking his deep research and analysis. In fact, I applaud his diligence and ability to discover serious flaws in that corner of the market whilst everyone else it seemed was asleep at the wheel. Yet I don’t think it was a smart move for the following reasons. Firstly, his move to short those bonds represented a very high percentage of his total fund, which made a lot of investors very nervous. If you are a fund manager or work for a fund, it is quite common for an individual security to not represent more than 10% of the total fund. Anything higher than that percentage has the potential to create a lot more risk and volatility to the fund. What’s more, it was expensive to hold such a large short position as large payments to service it were due every month. It was understandable why those investors and others at his fund were nervous and had very little patience. Secondly, and more importantly, I don’t think Burry ever familiarised himself with Keynes’ quote. Although it took about two years for his bet to come good it could have taken much much longer. It is entirely plausible that had his fund had to wait even longer for his bet to come good there would have been so much pressure on Burry to finally close his short and thus cut the loses the fund was making by holding it.
You see it doesn’t matter whether Burry was fundamentally right in his analysis. He was completely correct. These bonds were a train wreck waiting to happen. But that’s not the point. The point is that timing the markets is very very difficult. Alternatively, Burry could have done the following. He could have still made his bet yet it wouldn’t have represented more than 10% of his total fund for example. That way, there would be less tension and pressure on Burry to close his position in the event that it was going to take so long to come good. What’s more, it would have still made him and the investors in his fund a lot of money when that day would eventually arrive.
This brings me to another well worn adage in the investment world of never having all your eggs in one basket. Although this may be a cliché it is so very true. Although enormous fortunes are made by putting all one’s huevos in one single basket, it is also the fastest way to blow up a portfolio. Burry’s enormous bet came good and he was rewarded, but he could also have been fooled by randomness by some unusual twist of fate.
Over the last few years many investors, including some well known names, lost a lot of money shorting Tesla. Although the rationale behind their decision to short the company was completely understandable, namely that the market capitalisation of the company was not reflective of it’s fundamentals, the share price has nonetheless continued to climb even higher. This right there should be a warning in the perils of going for that ‘big short’. As I already stated, it is ok if such a position is not so great that it poses a serious risk to an entire portfolio. But one can only imagine those legions of investors having a Michael Burry style moment with Elon Musk’s company.
Interestingly, it seems that Burry himself has now thrown his hat in the Tesla Short ring. I may be wrong, but it appears that his fund is betting against Tesla to the tune of 40% of the entire weighting of the fund. I wish him luck. Will his bet come good again? Or will he join the scores of other investors who got badly burnt betting against Elon?
Start-ups are an important part of the business landscape. More crucially, the best start-ups provide much needed solutions to long standing problems. They provide real value to consumers. However, one thing I have observed over the years with certain start-ups is this mantra of ‘growth at all costs’.
If you are the founder of a start-up that provides a product or service that people really need and for a reasonable price, it is fair to say that this start-up has a bright future with a large potential for sizable growth over the coming months and years. That is all well. Yet, it does concern me when I observe the ones that have this ‘growth at all costs’ mindset.
No matter how driven or ambitious a founder may be, it is absolutely paramount that there is a healthy working environment amongst all the people who work at the company. There is currently a huge scandal with the UK craft beer company BrewDog over the maltreatment of many of its workers. BrewDog has been a huge success story. Ever since it’s founding a little over a decade ago, it has grown exponentially and is now the largest craft beer company in the country. It’s become a ubiquitous brand with it’s beers sold in all major supermarkets.
I could be wrong, but I am guessing that during those years when BrewDog was growing at such a fast pace, there was very much a ‘if you can’t stand the heat..’ atmosphere in the organisation. Even though BrewDog do make very good beers, the craft brewery industry is very competitive. There are many players and the way that BrewDog has been able to get to the position it is currently at today has been by scaling very fast in a relatively short period of time. By growing at such a rapid pace, it has now got to a size that gives it a clear edge over it’s competitors. If it had not embarked on this journey of aggressive growth it likely would have lost out to another competitor in the space.
Yet a big consequence of adopting an aggressive growth strategy is that it can create a toxic environment in the workplace. It suddenly becomes very easy for founders/chief executives to forget to care about the wellbeing of the other workers in the organisation as, in an almost single minded fashion, they have their eyes set on reaching their lofty targets they have set themselves out to achieve. They fail to understand that the workers are an integral part of the growth/success of their business. Without those workers, it is unlikely that their company would have been able to grow so spectacularly. This is especially true of those founders with very large egos and a lack of empathy for others.
A more extreme example of a growth at all costs business that makes Brewdog look like a plain vanilla enterprise is the rise and fall of office rental space company WeWork under the leadership of it’s colourful founder Adam Neumann. Unlike Brewdog, WeWork never made a profit and simply haemorrhaged cash. Billions of dollars of venture capital money was thrown at the company, most notably by Softbank whose founder and CEO, Masayoshi Son, really believed in the company. At one point WeWork had a valuation of over $40 billion. An eye watering valuation when one takes into account the fundamentals of the business.
WeWork also suffered from a toxic workplace culture. Those Brewdog workers, who via the Twitter group Punks With Purpose are bringing to light the less than perfect behind the scenes picture of the business, accuse the company of being ‘built on a cult of personality’. They take aim at how the company and it’s founders cultivated an image of the company as authentic (applying a ‘punk ethos’), caring about the environment, being forward thinking and progressive, and an amazing and cutting edge place to work at. Yet the irony is that it was anything but rosy. In their own words they scathingly say that “The true culture of Brewdog is and seemingly always has been, fear”.
Yet compared with WeWork this is small beer (no pun intended). The larger than life WeWork founder Adam Naumann would make make Brewdog co-founders James Watt and Martin Dickie blush. He took the term ‘cult of personality’ to another level. To the point where he was able to get some of the most powerful heavyweights in the venture capital space to invest megabucks in his business. Even though, with just a modicum of due diligence, it would soon seem apparent that WeWork was essentially a start-up with very poor fundamentals. The emperor had no clothes. Those VCs who were smart enough to see beyond the hype and mega personality of Neumann and actually did some stone cold research on the fundamentals of his business, saved themselves a packet.
Sometimes it is not necessary for a start-up to pursue a ‘growth on steroids’ strategy. It may be that you can create a lot of value and provide a unique solution without the need to aggressively grow. Sometimes large growth can happen by default if suddenly there is a massive demand for your products and services. And that is fine. There is nothing wrong with growth. Hell, there is nothing wrong with full on hyper growth. But not when it’s at all costs. Not when workers are not feeling valued and a dysfunctional and toxic workplace environment manifests.
Before you decide to invest in a company, start-up or venture that is highly risky, there is one very important rule that all investors should heed. We are all aware of the obvious rules such as doing sufficient due diligence and only investing what we can truly afford to lose. However, a less obvious rule, and the one which I am talking about in this article, is focused on having Skin In The Game.
The origin of this phrase is debatable although a quick Wikipedia search tells me that it originates from derby races whereby the owners of the horses taking part in these races have ‘skin’ in ‘the game’. More recently, it has been written about extensively in the works of Nassim Nicholas Taleb. Put simply, it refers to how much ‘skin’ a person has in something or how much personal risk they are willing to take on. For example, in the case of entrepreneurs or founders of businesses, an entrepreneur who has the vast majority of their net wealth tied up in their business has considerable Skin In The Game. Even though they will be handsomely rewarded if the company is successful, they will also go down with the ship and face financial ruin if the company goes belly up. This latter point is crucial.
When I analyse high risk ventures, one thing that is a huge red flag for me is a genuine absence of Skin In The Game. A founder or director of such a company needs to have the majority of their own capital invested. ‘Share options’ do not count. However, ‘director buys’ do.
Another red flag is when founders and directors draw huge salaries, especially if the company is not currently generating any revenues. If a company is not yet making money, a company will be raising money via debt or equity placings (issuing more shares) to keep it a going concern. This is precious cash and should not be eaten up in the form of generous remuneration packages. Alarm bells should be ringing if this is the case.
Founders and directors who have a considerable amount of Skin In The Game in a venture is an indication not only that they truly believe in what they are working on and executing, but also that they are motivated and kept under a considerable amount of pressure to ensure that the company succeeds. They believe in the company so much that they are more than willing to match their considerable belief via taking on a considerable amount of personal monetary risk. If the company doesn’t succeed they will be financially ruined. There will be no government or organisation ready to bail them out if they fail.
I have seen so many high risk ventures collapse where the founders and directors have come out of the wreckage mostly unharmed. They always drew big salaries and their equity stakes were mostly in the form of options rather than purchased with their own money. Founders and directors with little to no Skin In The Game are not under any acute pressure to contribute in the best ways they can. They don’t believe in the company they are working for nor is their heart really in it. It is merely a gravy train.
Thus, before deciding to invest in a company, start-up, venture or anything that is highly risky, one should always ask, ‘How much Skin In The Game do the founders and directors have?’
It is natural to get in the habit of trying to buy or sell shares at a particular price. Sometimes we may get lucky and reach our desired entry or exit point. Other times, we may not always get what we want in this respect. I fall into this trap myself a lot of the time, yet, perhaps unwittingly, am I playing a mugs game?
The future is uncertain. Nobody can predict the future and don’t believe anyone who tells you otherwise. I have written articles where I have talked about where I think certain things may be going, but the truth is anything can happen. I know nothing. Even if we have deep and unmatched levels of foresight we can so very easily, in the words of Nassim Nicholas Taleb, be fooled by randomness. We can be knocked off our perch by completely random and unforeseen events way out of our control. This is one reason why it is important to have a diversified and balanced investment portfolio. If one sector or stock is particularly badly hit by some unexpected event, at least your other investments in other stocks and sectors are not affected. That old chestnut of ‘not keeping all your eggs in one basket’, whilst it may sound hackneyed, still rings true.
Whilst we may or may not be able to get our desired buy or sell price for a particular stock, one thing we do have complete control over is how we weigh and structure our investment portfolios. There may be a company you highly rate and want to invest in, but you want to invest in it at the right price. Right now, you consider the current price too high and have lower price in mind that you hope will arrive. But what happens if that price never comes and instead the share price of the company just continues to climb in value? Instead of hoping to get the right price, or worse, the lowest price, why not say to yourself, ‘What percentage of my total investment portfolio do I want this company or security to represent?’. I think dealing in percentages rather than prices can not only help you to be a better investor, as it can take away a lot of the unnecessary stress and anxiety associated with trying to buy or sell a security at ‘the right price’. It can also help you overcome deeply ingrained cognitive biases.
When you focus more on what percentage of your investment portfolio you want a security to represent, rather than chasing a price, that can give you more control and balance. If the investment goes down in value, the percentage weighting it represents in your portfolio also goes down. If the investment goes up in value, it’s percentage weighting also goes up. By this you can then decide whether you want to be more overweight or underweight in the percentage weight of this particular security. If you want to be more overweight, you buy more. If you want to be more underweight, you sell a portion.
The percentage of what a security represents of your total portfolio is in many ways more important than the price you pay for it. Even if you end up overpaying for a stock or security, if it represents a percentage of your portfolio that is not too detrimental to the overall performance than it is not so bad.
Money can buy you freedom. That’s it. Not as a means for conspicuous consumption, gaining status or power, or indulging in an eternal cornucopia of mindless, decadent pleasure and self-indulgence.
The Twitter account Orange Book (@orangebook_) recently posted the following tweet…
Things money can buy:
-freedom to think -freedom to travel -freedom from jerks -freedom to learn slowly -freedom from an alarm clock -freedom from work you dislike -freedom from financial anxiety -freedom from low-cost nutrition -freedom to pursue a creative purpose
I could add more things to this list…
-freedom to create and invest in ventures that make the world a better place
-freedom to be time rich
-freedom to afford better healthcare
-freedom to help others
All of this is very positive, however there are downsides too. For example, I would include the following…
-freedom to run away from problems
-freedom to avoid the unsavoury aspects of life
-freedom to not live in the real world
-freedom not to grow
As much as having money shields us from the unpleasant aspects of life; from jerks, from jobs we hate etc ; if we never have to deal with these unsavoury aspects of life, this can put us in a very vulnerable and fragile situation if, by some random stroke of misfortune, we ended up in a no money situation. The freedom that money provided in the past is gone at the drop of a stone. When previously, money offered a means to be cocooned from the real world, not having any money now throws us back into it.
It is much better to have money, but at the same time, know how to deal with the real world, how to deal with challenging situations, how to deal with difficult people. This is because, if we ever find ourselves back to a situation without money, then life is not a constant struggle.
Investing successfully requires a lot of boring fundamental analysis and often the best stocks to invest in are in boring overlooked, but undervalued companies with strong fundamentals and a decent margin of safety. These companies are not prone to hype.
On the other hand you have story stocks. Investing in a story stock does not mean that your investment will go down in value. On the contrary, a stock with a powerful story could make you very rich. Look at Amazon. Then again look at the multitude of other stocks, which had a powerful story behind them, but that was it. Fundamentally they were houses made of cards, which soon collapsed. The Dot.com crash from twenty years ago is littered with such casualties. More recently, the whole WeWork disaster is a prime example of company with an enticing and exciting story (as well as a charismatic and convincing leader), yet with very shaky and fragile financial fundamentals.
The problem with story stocks is that the stock valuation gets to a point where it is propped up much more by the goodwill of the story alone than by the company’s fundamentals. This is very treacherous territory as even a mild downtown or modest bit of bad news can send the share price crashing back down to Earth.
A stock with a unique story behind it is psychologically very alluring. Doing some solid due diligence such as analysing company reports and financial statements requires effort and if you dont have much experience on that front it can seem very daunting. However, with practice and learning you can become better at analysing and understanding all this nitty-gritty stuff, which also enables you to make better investment decisions with a cool head. Knowing exactly what you are investing in and having even just a modest understanding of the full financial health of a company is a very reassuring thing.
I suppose we prefer stories to analysis, because stories have much more of an instant cognitive resonance. Our minds can be lazy and it’s so much easier and more soothing to be swayed by a good story or glowing article in the media on a stock. More succinctly, sometimes a powerful mantra alone is enough to sway us. Software is eating the world or It’s the wave of the future or You are investing in a slice of history or Nobody else is doing what this company is doing are a handful of mantras that can make us overly bullish on a particular stock without questioning it further or taking it apart via some deep research.
The problem with such stories and mantras is that they activate and play to our emotions and making investment decisions based on emotions is never smart. We always have to have a healthy, balanced, critical and analytical mindset to investing without allowing our emotions to hijack and influence our decision making. A cool head always wins.
There are two Scottish funds listed on the London Stock Exchange, which I would like to focus on in this article. They both have similar names, yet their investment strategies differ considerably. The first of these two funds, The Scottish Investment Trust, is a contrarian value fund. Whilst the second fund, the Scottish Mortgage Investment Trust, is a growth fund.
The Scottish Investment Trust (SCIN) is over 130 years old and was first established in Edinburgh in 1887. Since 2015, the fund has been managed by Alasdair McKinnon with a focus on blue chip dividend paying companies that are out of favour. McKinnon takes a contrarian view to investing avoiding sectors that are hot and investing in companies that are undervalued and where sentiment is poor. The rationale being that when sentiment turns, the value of the companies increase as investors begin to pile in. To be clear, contrarian and value investing don’t mean simply investing in any old company that is down and out and going through a turbulant period. It is important that the company has a margin of safety to ride out any difficult period thus protecting it from having to raise emergency cash and/or ceasing to remain a going concern. It is also equally important that the company has healthy cash flows and a decent track record of this. The amount of cash that a company generates from its operations is a crucial metric and sometimes overlooked. A low P/E (Price To Earnings) ratio is one thing and a significant metric in indicating whether or not a company is overvalued, yet it doesn’t tell the whole story. The level of cashflow generation indicates how much cash a company is generating and the more cash it generates, the more of a financial buffer it has, especially if it’s total operating margins are not very high. It is also important to monitor a company’s total liabilities and how manageable and sustainable they are.
As of 30th April 2020, the largest holdings in SCIN’s portfolio included large gold mining companies such as Barrick Gold and Newmont Mining, large pharmaceutical companies such as Roche, Pfizer and Gilead Sciences and other assorted value blue chips such as United Utilities, Japan Tobacco, BT and Chevron. The gold mining companies have been in the portfolio for sometime. Recently gold has performed very strongly and it’s likely to continue. McKinnon, like myself, is of the view that major fiat currencies run the risk of being debased. Since the last financial crisis in 2008, we have been living through a period of very low interest rates and easy money. The present COVID-19 crisis has only exacerbated this as central banks have reduced interest rates even more and printed unprecedented amounts of money to prop up national economies in the wake of this crisis. Add to this the staggering levels of global government, corporate and household debt and you have a rather fragile situation. McKinnon’s thesis for having exposure to gold is as a form of insurance against this extraordinary macro environment and the real future risks and consequences it carries. He is also no fool by investing only in the biggest and most geographically spread global mining companies with low production costs. Whilst it is true that gold may not currently be unloved, I would still consider it a contrarian investment as it represents, to a degree, a lack of faith and trust in central banks and governments. It is also considered unfashionable. I would argue that newer supply-capped digital cryptocurrencies such a Bitcoin are more fashionable and hotter than gold. Especially amongst younger investors who generally overlook gold and other precious metals as a store of value.
McKinnon deliberately stays away from sectors that are hot and fashionable such as the technology sector. SCIN has absolutely no exposure to FANG (Facebook, Amazon, Netflix, Google) stocks or any other hot tech/startup stocks. The closest thing to tech in the portfolio are it’s holdings in boring and undervalued blue chip communication service companies such as BT, China Mobile, Verizon and Deutsche Telekom. McKinnon believes that the tide will turn regarding the high valuation of many technology companies, as unlikely as this may currently seem, and that value stocks, for a long time overlooked and underperforming compared with their growth counterparts, will prevail in due course.
The Scottish Mortgage Investment Trust (SMT) is currently the most valuable investment trust by market capitalization listed on the London Stock Exchange. As of today, it has a total market cap in excess of £10bn and over the last decade has performed extremely well. The primary reason for its impressive performance has been it’s exposure to all the FANG companies plus a number of other tech investments that have recently done exceptionally well. For example, the fund has a substantial holding in Tesla, whose share price has more than doubled since the beginning of this year. Generally speaking, tech shares have done very well since the COVID-19 induced lockdown measures were put in place over the last few months and the share price of SMT is trading at all time highs.
SMT, like SCIN, is also a very old investment trust with a hundred year plus history having first been established in 1909. It is currently jointly managed by James Anderson and Tom Slater. Anderson has been managing the trust for 20 years with Slater joining him in 2010. Their focus is purely on growth and investing in companies of the future. SMT is everything that SCIN is not. SCIN adopts a Benjamin Graham style value investing strategy. SMT does not embrace this type of strategy and even questions it. This is highlighted in a series of interesting essays written by Anderson and published on the fund’s parent Ballie Gifford website entitled Graham Or Growth?. I highly recommend giving them a read as it provides one with unique insights into Anderson’s way of thinking and by extension the investment philosophy and strategies of SMT.
It is true that growth investing has greatly outperformed value investing since the last financial crisis more than a decade ago. At the very start of 2009 the Russell 1000 Growth Index (RLG) was around 360 points. Today it is almost 1820 points. In this time the RLG index has grown more than 500%. That is highly impressive. By comparison the Russell 1000 Value Index (RLV) was around 446 points on 1st January 2009. Back then the RLV index was higher than the RLG index. The same cannot be said today with the RLV index almost 1,105 points. The RLV index has grown less than 250% during this period. Whilst this is certainly not a poor return, it doesn’t hold a candle to the RLG index’s 500% plus return.
Regardless of which side of the fence I am on regarding value or growth investing, it cannot be denied that both Anderson and Slater are highly skilled and visionary managers with a highly impressive track record for picking winners. It is much harder to quantify growth stocks than value stocks via traditional metrics and methods of fundamental analysis. If one were to just use just those methods when investing, one would have passed on investing in Amazon, Alphabet or Tesla in the early stages of their listings in the public markets. It takes more than just the tried and tested strategies of the past to value these companies and Anderson’s essays make this very clear.
However, it is just simply not the case that all new and exciting tech companies are ‘crushing it’. There have already been some casualties. The one that springs most to my mind has been the downfall of workspace company WeWork. Before the issues of the company came to the fore, it had a valuation of $47bn even though it had vast amounts of debt. Today, it’s worth far less at around $3-4bn. One of the largest investors in the company is SoftBank whose Vision Fund took a massive hit. Fortunately, SMT and its parent company Baillie Gifford, never built up a stake in WeWork over the years, but it could have easily happened here.
The recent WeWork debacle is one of a number reasons that make me nervous about having too much exposure to SMT right now irrespective of its stellar performance. As much as I respect the vision and foresight of Anderson and Slater, I worry that their fund could come a cropper some time down the line if a number of the holdings in the SMT portfolio underwent similar write-offs in value like WeWork. One of the fund’s holdings, Tesla, is probably the most polarised and hyped publicly traded stock in the world today. I have a great respect for its founder Elon Musk, who is a highly driven and exponentially thinking visionary. There is no doubt in my mind that he is special. However, the company could very easily experience a similar WeWork style crisis. No matter how highly I rate Elon, the financial fundamentals of Tesla are fragile and the share price could dive spectacularly in the event of a major existential crisis. This would create a huge dent in the value of SMT, as its Tesla holding currently represents a chunky 10% of the entire portfolio. Together with Amazon (which also represents 10% of the total holdings), it is one of the largest holdings in the SMT portfolio.
McKinnon is very wary of the present high valuations of tech companies and has citied the WeWork situation as a clear and present danger. In a post from December 2019 entitled Peak Unicorn?, he refers to the overvaluation of these exciting multi-billion dollar valued unicorn story stocks as a ‘disruption’ bubble, which has been propped up by an environment of cheap money and will not end well.
The last ten years have been very good for growth and technology stocks, yet it remains to be seen whether the next ten years will be equally magnanimous.