We are the Renegades of Funk. Or, if you prefer The Jedi. Sometimes it feels like treating the valuation of equities as a SCIENCE, as it should be, is a lost art practiced by only a few of us. I try not to disrespect those who serve by using a military metaphor to describe something as prosaic as attempting to fairly value a company, but it does feel like a war sometimes.
There is just an army of people on the American financial media that never use even a single mathematical idea to try and divine the value of a stock or, more broadly, the fair value of the stock market which is of course composed of individual stocks. Tune them out!
If 2020 has taught us anything it is that most of the American media - and that most assuredly includes social media and its one-sided, Bradbury-esque censorship - is a completely useless. Ignore them!
As we get to the end of 2020, I really have no idea what "they" are saying about the stock market entering 2021. I honestly don't care. I will continue to hew to the motto of my firm: cash flow never lies.
That's where valuation is paramount. The 2020 stock market is filled with people using newfangled media methods to obfuscate and make excuses for companies that don't produce cash flow in excess of the cost of capital needed to generate those returns. We are partying like it's 1999.
I actually lived through the Tech Bubble as a Wall Street analyst and the lesson is an easy one. Promises made through hip buzzwords to justify ridiculous valuations simply never came true.
But, again, the numbers tell the story and not the other way around. Don't forget that. Many use pets.com as an example of the excesses of the (first) tech Bubble. That company's extraordinarily fast journey from start-up to public company to bankruptcy failure is well-documented. What most people miss, however, is that delivering pet supplies based on internet orders to far-flung customers is actually a very good idea. You think Lil' Jeffy B up in Seattle never thought of that? Of course he did.
But the reason Amazon (AMZN) succeeded where pets.com failed is a simple one: in delivery retail, scale is paramount. Large bags of dog food are really heavy and thus really expensive to ship. That's what killed pets.com. Amazon obviously crossed that scale threshold in millions of different SKUs a decade ago, and so the company is able to earn attractive returns on its capital and keep its shareholders happy without benefit of receiving a dividend. Lil' Jeffy B can take market share from just about anyone.
But very few consumer products companies possess that scale. That is where electric cars and the Magical Mystery Tour that is Tesla's (TSLA) stock price simply make no sense to me, a long-time car industry analyst. Tesla only generated positive cash flow last quarter because it accounts for its factory in Lingang China using an operating lease, not a direct capital expenditure. That is CFA Level I-stuff, and anybody should be able to see that. Amazon -another reference - offers supplement data to analysts that presents its facilities accounted for under operating leases as if they were bought and paid for. On that basis, AMZN STILL generates positive cash flow, but if Tesla did the same, their cash flow would have been negative last quarter, and probably would be forever.
Focus! Pay attention to this stuff! It matters! Longer-term returns on capital (shareholder's equity being the most obvious) are the sole driver for economic value creation. Apple (AAPL) does it incredibly well, as do Amazon, Microsoft (MSFT) and other tech titans. It's not just an "old economy" fuddy-duddy thing. It's actually the only thing.
But when you try to tell me, and my cadre of data nerds - what I used to refer to as the Portfolio Guru Army, but, again, sorry for the military reference - that returns on capital don't matter because of "disruption" or other such silly constructs, we tune you out. Feel free to overpay for Airbnb (ABNB) , DoorDash (DASH) and other hot IPOs. That worked really well in 2000, let's see how it works out in 2021. Also, by all means, invest in assets like cryptocurrencies that - even after Bitcoin's extraordinary run which has given it a larger market cap than Berkshire Hathaway (BRK.A) (BRK.B) - still have ZERO intrinsic value. I will not be joining you, and hopefully the other Renegades will pass, as well.
I run two separate small businesses, and believe me when I tell you that I know the return on EVERY dime that I have invested in them. So does Buffett, I would think, even for an enterprise as diversified as Berkshire Hathaway. Cash flow never lies, but the stock market can, and for more than one day, week, or even year.
Don't get fooled again!