Tesla And The Horse Race

Elon Musk never ceases to amaze me. He is obviously brilliant and one of the great visionaries of our time. I respect his relentlessness and envy all that he has accomplished in such a short amount of time. That being said, his love of the spotlight might spell trouble for investors. He is volatile and such volatility can be scary. Who knows what he might tweet next? “I’ve decided to retire from Tesla and teach a heard of sheep to communicate through a series of blinks.” “My intern looked at me funny yesterday, I have removed the entire executive staff.” I don’t know what to expect next, but I do love the ride. It is incredibly exciting to watch, but as an investor I find it best to just steer clear of Tesla. They very well could become the world’s greatest company, it just isn’t worth the risk in my book. GARP investing is about compounding safely. We are playing a game of probabilities and there is a far larger than 0% chance this could all blow up and go to 0.

The Parimutuel System 

Investing is a lot like betting on a horse race. I’ll leave it up to the always cheerful Charlie Munger to explain, he is far wiser than I could ever hope of becoming. Here is an excerpt from his article

A Lesson on Elementary, Worldly Wisdom As It Relates to Investment Management & Business.

The model I like—to sort of simplify the notion of what goes on in a market from common stocks—is the pari-mutual system at the racetrack. If you stop to think about it, a pari-mutual system is a market. Everybody goes there and bets and the odds change based on what has been bet. That is what happens in a stock market.

Any damn fool can see that a horse carrying a light weight with a wonderful win rate and a good post position etc., etc. is way more likely to win than a horse with a terrible record and extra weight and so on and so on. But if you look at the damn odds, the bad horse pays 100 to 1, whereas the good horse pays 3 to 2. Then it is not clear which is statistically the best bet using the mathematics of Fermet and Pascal.

The prices have changed in such a way that it is very heard to beat the system.
And then the track is taking 17% of the top. So not only do you have to outwit all the other betters, but you have got to outwit them by such a big margin that on average you can afford to take 17% of your gross bets off the top and give it to the house
before the rest of your money can be put to work.

To simplify, we are looking to find a misplaced bet. It isn’t hard to tell what horse is the biggest and strongest. What is hard is figuring out which horse is trading at the best chance of winning given their odds. Let’s examine Tesla’s horse racing situation:

Tesla itself is a fine horse. They create great products that consumers love. Elon Musk is a true visionary and therefore a very able jockey. That all sounds great, but this isn’t an easy horse race. They are up against some of the finest horses around. American companies GM and Ford are strong entrenched competitors, having been in business for over a century. They also must face off against technological juggernauts from Japan and the elite engineering of the Germans. Not to mention the dozens of other brands that have found their own footholds.

If that weren’t tough enough, Tesla is being priced for perfection. They are no longer a small start up worth a couple of billion dollars. They have a market cap of nearly 50 billion, larger than GM or Ford. They are priced to be the leader in car manufacturing without yet proving they can do so. Maybe they can, but that doesn’t mean I have to place a bet.

I prefer to bet on a race that doesn’t leave so much up to chance. What us GARP investors are looking for is a race with a dominant horse that is getting faster, led by a great jockey who has weak competition. This is the horse racing equivalent of a moat. The next step is to examine the betting odds. Everyone can identify when there is a leader with no competition and therefore the odds become unfavorable. Think about basketball for a second. If we bet on the Golden State Warriors to win another championship, our odds aren’t going to be great. Everyone knows they are elite and therefore the payout is minimal. Therefore we want misjudged odds where we can find value. If we can find those variables we should place our bet and bet big.

Conclusion

I find everything about Tesla to be fascinating. Musk is truly one of a kind and I can’t wait to see what happens next. That being said, I think it is wise to avoid investing in TSLA. I choose instead to look for stocks that are simpler and less risky.

As always thanks for reading and subscribe to see what’s next!

The Double Dip!

I’ve gone ahead and hitched my wagon to Mark Zuckerberg. I bought 5 shares of FB on Friday for $878.90 and another share on Tuesday for $168.94 after seeing the company fall another 3.5% for a grand total of $1,047.84. I broke one of my original rules, never go above 10% in one company. Rules however are meant to be broken, I saw an opportunity and jumped on it. Besides I only stuck a toe over that 10% line.

I also purchased 5 shares of IPGP, the premier laser company in the world. Shares were down over 4% today, so I used this as a buying opportunity. I got in at $161.74 a piece for a total of $808.70. I continue to love the company and consider this to just be a blip on the radar.

For those keeping track, I now own 4 stocks and still have $6,723 out of my original 10K with which to buy more!

Why Facebook?

Facebook is one of the most phenomenal companies of my investing lifetime. Started in 2004, they are already one of the largest companies in the world. They IPO’d in 2012 at a market cap of 104 Billion. They now sit at 412 Billion meaning they have come close to quadrupling in that time period. Will they quadruple again over the next 6 years? Most likely not, but I wouldn’t completely rule it out. I do however think they have a great chance of outperforming the S&P 500 over the next 5 to 10 years by a considerable margin.

Commonly lumped in to a group called FANG stocks, I actually think they share a lot more in common with Google and Microsoft than they do with Netflix and Amazon. I find Amazon and Netflix to be almost impossible to value. They are great companies that provide incredible products to their consumers. That being said, Netflix continues to be cash flow negative and Amazon is in a world of their own in terms of valuation. I’d rather just stay away. Facebook, Google and Microsoft can all be valued by traditional value investing principles. They create meaningful profits and turn those profits into incredible amounts of free cash flow.

Let’s look at what makes Facebook so compelling. Over the last 5 years, sales have skyrocketed from 7.8 billion to 40.6 billion. This gives us a CAGR of 38.87%. EPS grew from .6 to 6.16 over the same time period, giving us a CAGR of 58.87%. It doesn’t take a rocket scientist to tell this is phenomenal. FB now sits at a P/E of 23.65, a laughably low number considering how fast it has grown in the past. They are sitting on 41 Billion dollars of cash and short term investments without having a single dollar of debt. That is simply incredible.

The past however does not automatically promise future performance. We have to examine what Facebook’s future holds. After their latest quarterly release, the stock plummeted from fears of reduction in future growth. I find these fears unfounded. Of course FB has to slow down. If they continued to compound above 50%, they would be bigger than the entire S&P in a short amount of time.

In the short term, there will be pain. Just today, representatives of the company are testifying before congress about what they can do to stop meddling in the midterm elections. This once again represents short term thinking. Facebook is a platform that is singlehandedly strong enough to affect a US election. That power is only growing stronger. They have daily users that number almost 1.5 billion and monthly users above 2.2 billion. They have barely even started monetizing the platform. Just the talk that FB could get into dating caused dating juggernaut Match Group’s stock to fall 20% in a day. It is a platform of strength never before seen in US history.

Instagram

I have yet to even mention Instagram, one of the most popular social media platforms and one of Facebook’s chief “competitors.” You see, Facebook bought Instagram for 1 Billion in 2012, proving they have their eye on the ball in the acquisition space. Some estimate Instagram alone could be worth upwards of 100 billion, 1/4 FB‘s total market cap. Yesterday rumors abounded that Instagram is developing a new shopping app. This platform is still in its infancy, just figuring out ways to monetize for shareholders.

The truth is we don’t know what the future holds for this company. We can merely look at their past success and determine whether we think the future is bright. In my opinion Facebook will be a trillion dollar company in the not too distant future and who knows how large it could grow. Stop thinking in the short term, but determine whether you want to own a company for the next decade.

Lasers

IPGP holds a particularly soft spot in my heart. You see for a while, it was by far my best investment ever. Within a year of buying it in my personal account, I had gained over 200% more than tripling my initial investment. Of course, nothing is ever as good as it seems. While the business was going gangbusters, the Trump administration laid out tariffs that have caused Chinese companies(IPGP‘s largest customers) to reconsider how much they will spend on capital expenditures. You see, lasers powered technology are large up front capital requirements and given a trade war, companies don’t want to commit to large spending given the uncertainty. That 200% investment within one year has fallen to a 100% gain within two. Still not too shabby!

I’m willing to sustain some short term pressure to buy into a fantastic company with long term advantages. IPGP sells lasers that enable manufacturers to cut their costs. A business that allows their consumers to cut their own costs has a recipe for success. They are simply selling a better technology. Metal cutting and abrasion systems wear out, whereas lasers are more precise, cost less and last longer. This has translated into robust sales growth, which has in turn led to much greater profits.

Given how long I talked about FB, I didn’t want to get too far into the weeds with IPGP. Just know they are a great company with a long track record. They have a squeaky clean balance sheet and generate loads of cash. Who knows how long this trade war will last, but when its over, I expect IPGP to burst out of the gate at a sprint. I’m willing to hold on to this gem for the very long term.

As always, thanks for reading and subscribe!

 

Stock #2 (HII)

I logged on this morning and bought my second stock for the portfolio. Huntington Ingalls Industries (HII) is a military shipbuilder and the leading supplier of the United States military. I got in today at $249.00 and purchased 3 shares for a total of $747.00. I still have $8,579.88 of cash left in my 10K Portfolio.

Why HII?

From a broad perspective, I often like to have an impetus behind an investment. You need to be able to tell a story and then focus in on the minutia. Looking at the Trump administration, I don’t think it is a stretch to say he favors a growing military budget. This set me on a quest to look at all the public military contractors. One thing I noticed is that they are almost all great companies. It is no wonder the US military spending is so large and growing. From there I determined HII was my favorite and have been following it ever since.

Huntigton Ingalls is a classic high moat company. They are the leading supplier of the US Navy, supplying over 70% of all ships. They are the only company capable of building and refueling nuclear-powered aircraft carriers and one of only two that can build a nuclear powered submarine. They were spun off from Northrop Grumman in 2011. Spin offs are often a good candidate for research, as they are not always properly valued. Seven years later, HII continues to gain market share and grow their earnings.

HII generates ample free cash flow each and every year. You might start to sense a theme, I prefer companies with lots of leftover cash ever year. This gives a company flexibility, they aren’t constrained to any one strategy. Should they see a good acquisition opportunity then great, otherwise they can pay out dividends or buy back shares of the company. The board recently increased the buyback allowance from 1.2 billion to 2.2 billion. If my math suits me correctly 2.2 billion is just over 20% of the entire company. They won’t buy it all back overnight, but the share count should fall dramatically over time.

While 2017 wasn’t quite a banner year, they more than made up for it in the first half of 2018. Due to lower taxes, a reduced share count and higher sales and margins earnings increased YoY from 3.21 to 5.40. That’s an increase of 68% in a single calendar year. While we can’t expect such growth going forward, that would be impossible. The company will continue to perform with precision.

Conclusion

Huntington Ingalls is a simple but extremely well run company. They will never be the fastest growing company, but they are almost guaranteed to grow at a decent clip over time. They have a growing backlog that will keep them busy for years to come. As of the end of 2017 their backlog stood at $21.4 billion. The company will continue to buy back shares and grow their earnings. They are trading at a reasonable multiple and over the course of 5-10 years the company will be considerably larger.