Q3 Update

2020 has been a remarkably odd time to be an investor. Granted, it has been an incredibly strange time to be alive in general. It is now October and Covid continues to rage on, a seemingly never ending storm without respite. Our President just tested positive for the virus and has entered the hospital. He has the best medical care and will therefore almost assuredly be fine, but you never know. The word has been used over and over, but that is because it rings true, these are unprecedented times. I think we would all like to just get this chapter over and move on with our lives. With an election right around the corner however, I expect more volatility to be on the horizon. I’m not one to make market forecasts, but I would not be surprised to see some pretty big swings in the near future.

Q3 Performance

As of 10/1/2020, my 10K portfolio stood at $13,047.01. When I started on 8/19/18, the SPY had a price of $285.06 and my account started with $10,000. As of 10/1/2020 the SPY had a price of $334.89. In reality, the SPY has done even better due to dividends given out, so I have accounted for dividend reinvestment in the return calculations.

10K Return(1)SPY Return(2)Difference(1-2)
2018(8/19-12/31)(13.95)(13.71)(.24)
201937.3332.64.73
2020(1/1-9/30)10.415.325.09
Since Inception(8/19/18)30.4721.858.62

As we can see, I have done reasonably well in both 2020 and overall. I am by no means crushing the index, but a steady outperformance compounded over years can grow into a massive delta. If I can keep beating the S&P by 4-5% a year, I will be thrilled. So far, my GARP strategy has worked. I hope my portfolio keeps up the momentum, but don’t be surprised to see some reversion to the mean.

My stocks are now worth $12,778.29 and I am sitting on an additional $268.72 of cash, meaning I am almost fully invested. The market does appear to be frothy in my opinion, but in general I like to have my money invested rather than sitting on the sidelines. Should the market fall, I expect my companies to make intelligent capital allocation decisions, coming in the form of share buybacks or acquisitions of target companies at lower prices.

BUYS

INTC– I saw someone on Twitter(I would give credit, but I don’t remember who) mention that Intel shares looked attractive given current prices. I decided to take a look and based on numbers alone I liked what I saw. Problem was, the semiconductor industry was well outside of my circle of competence. I then went on to do a mini deep dive and educate myself. Admittedly, I will never be a semiconductor expert, far from it. But I think I have learned enough to be able to assess the competitive dynamics, time will tell if I am right or wrong.

So why the Intel discount, what’s the rub? Intel has been perceived to be in a losing CPU race against smaller faster competitors, AMD and Nvidia. They have the advantage of being fabless, in other words they do not manufacture chips themselves. Rather they design the chips and outsource manufacturing, mostly to TSMC, the Taiwanese semiconductor giant. TSMC brings fantastic technology to the table, enabling the smaller competitors to leapfrog over Intel in ultra high performance technology. This perception very well may be correct, but I feel it fails to paint the full picture. Intel is now so diversified that they are no longer completely reliant on the microprocessor. The second quarter of 2020 marked the first time that the data center portion of the business overtook the CPU portion, accounting for 52% of overall revenue. Data centric revenue was up 34% YoY. Certainly doesn’t look like a company on the brink of death to me.

Intel likely did take their eye off the ball and let competitors catch up in areas they previously held complete dominance. While Intel used to be a microprocessor company, they now are involved in so many different lines of business. Their focus has shifted to data, which they estimate to have a total TAM of $230 billion by 2030 according to this past quarter’s earnings transcript. This is significantly higher than the PC market TAM and Intel has therefore made it into the priority.

At the end of the day, Intel is still an incredible business that spins off loads of cash that can then be reinvested back into the business. In 2019, they spent 16.2B on CapEx and an additional 13.3B on R&D. That is 29.9B being spent on innovation and improvement, almost 3x what Nvidia and 5x what AMD did in total 2019 revenue. Intel trades at around 13x expected 2020 FCF, a deep discount to the rest of the market. I expect the company to continue to make use of their vast resources to invest in the future. Simultaneously, they will continue to pay out increasing dividends, make accretive acquisitions and opportunistically buyback shares.

CBOE- This one is a little less controversial and much less discussed on the Twitter-sphere. CBOE, which started as the Chicago Board Options Exchange but now goes by CBOE Global Markets, operates as a market maker, creating a marketplace for options and futures as well as a global stock exchange. It is a brilliant business model, they take none of the risk, but rather create the rails for others to work on. They exhibit classic GARP characteristics that I like to see, high return on invested capital and a capital light business. The business requires very little reinvestment, which allows the company to use their cash flow elsewhere. In 2019, they generated operating cash flow of $632 million. CapEx for the year was a mere $35 million. This left just under $600 million to be used in value creating activities. For instance in 2017, CBOE made a $3.2 billion acquisition of BATS Global Markets that has really bolstered the company. Since then, top line, bottom line and FCF have all grown considerably. I expect more large acquisitions in the future.

There is actually a whole group of companies working within this greater marketplace industry that exhibit superior economics. Just some examples are CME, Intercontinental Exchange and Market Axess. I happen to like CBOE the most at the moment given current prices, but they are all great companies. Should an opportunity come available, I could see myself owning one or more of these companies in the future. I’m actually surprised I have never seen Warren Buffett play in this sandbox. Seems to be right up his alley, but he has his reasons.

As always, I would like to thank you for taking the time out of your day to give this a read! Feel free to leave some comments or questions. Follow me on Twitter @TheGarpInvestor.

Updating The Watchlist

I’m not sure about the rest of you, but I have found myself with an abundance of time on my hands. I have spent the last couple of months quarantined to the house and much of my normal business work has been put on hold. I am not married and don’t have any kids, so let’s just say I have nothing but time. Watching Netflix and playing video games can only get me so far, so I figured I should at least be somewhat productive.

I have dedicated at least an hour or two every day to investment research. Some days I  have done far more than that, while others have gone completely wasted. What I can I say? I am human. Whether it is running screens, glancing through company financial statements, or reading 10Ks and quarterly transcripts, I have found the last couple of months to be the perfect time to learn.

Now is also an opportune time to update my company watchlist. I’m not sure what the next few months or even years will hold, but I am trying to get myself ready. Recently many of us tuned in to watch the Berkshire Hathaway annual meeting. Berkshire is now sitting on a record level of cash, over $130 billion. Buffett remarked that he wants to be prepared for any financial situation. Things could return to normal in a matter of weeks, but the Covid-19 numbers could spike and businesses could be forced to close for months further. If that should happen, economic calamity will ensue and I would assume that markets will drop into free fall. I want to have a list of companies ready to go for such a buying opportunity. I want to emphasize that this is not a prediction, but rather I am doing my best boy scout impersonation by being prepared.

The first companies on a watch list should always be ones you already own. These are companies you have studied and had the conviction to buy. Many variables have likely changed since the initial purchase, but that’s where research should begin. Check one by one and see how the businesses have performed. Have revenues and profits risen or fallen in recent quarters? Has their balance sheet held up, or have they taken on additional debt? Think into the future and consider where the obstacles might lie and whether they are still in a position to grow. Finally, when you have a good grasp on the business, look at the price. If the business scenario looks bright and the stock price is below your purchase price, that business is likely a good candidate for buying more. Conversely, if business conditions appear dour and the stock price has risen, you have a good indicator that it may be time to sell.

Aside from companies I have already invested in, I have compiled a short list of companies I am watching closely:

Comcast (CMCSA)- Look we all know them and if you are anything like me, you probably hate them. They may have terrible customer service, but that doesn’t change the fact that they are a phenomenal business. The cord cutting revolution was probably overblown, but it has been interesting to follow. As less people order cable, Comcast has simply raised prices on internet services. They are essentially an unregulated monopoly on a vital product. They are a cash machine, churning out a whopping 13 or 14 billion dollars of free cash in 2019 depending on how exactly how you measure it.

After a rather steep decline in the stock’s price, my interest has been piqued. Let’s be conservative and use the lower number 13.  Comcast now trades at 12.5x 2019 FCF, a very reasonable number. Much like Disney, we know the business will be adversely affected by the virus, they have been forced to close all Universal theme parks, a big money maker for the company, that comes along with high fixed costs. My real hesitancy however is the amount of debt the company holds on their balance sheet. Over 100 billion in debt and 180 billion in total liabilities. I need to dig in more before I would feel comfortable making an investment.

Copart (CPRT)- I just finished reading Junk to Gold: From Salvage to the World’s Largest Online Auto Auction, the story of Willis Johnson, founder of Copart. I encourage you all to pick up a copy, I thought it was a great short read. The book depicted his rise from humble beginnings to Copart’s domination of the auto salvage business. What started as just a tiny scrap yard has turned into the world’s largest auto auction business. It is a classic rags to riches story. Johnson is a tremendous entrepreneur and has a penchant for finding opportunities to make money in any situation.

Today, the company sits in a great position. Their financials look better every single year. In my opinion they are probably a bit expensive at current prices, but Copart will remain on my radar. They have a solid balance sheet and produce a fair amount of free cash. They reinvest that cash back into the business, which has allowed them to grow immensely.

Intel (INTC)- Intel is probably the company I am most interested at the current moment. It is a company you have probably all heard of, but may not actually know what they do. I understood what they did at a cursory level, but never did a deep dive until this quarantine began. I thought the semiconductor industry would be too difficult to understand, so I just skipped over it entirely. After taking a brief look through their financials however, I couldn’t push it off any longer.

Intel is the world’s largest designer and manufacturer of semiconductor chips used in virtually all computing equipment. Though they are known for their microprocessors, they design chips for a range of products from mobile phones to the self driving car. I admittedly will never understand the technical minutia of the industry, but I think I can at least understand the competitive dynamics and why Intel has been so successful.

Intel is the gorilla in the fight. With a market cap of around 260 billion and sales of over 70 billion in 2019, Intel is the major player in the US. To put that in context, their main American competitors, AMD and NVIDIA had sales of 6.7 billion and 10.9 billion respectively. In 2019 alone, Intel spent 13.3 billion on R&D and another 16.2 billion on CapEx. That means they spent just under 30 billion bettering their competitive advantage, all while spitting out over 15 billion in free cash flow. AMD and NVDA have found footholds in successful niches, but catching up to Intel in the overall market is incredibly tough. Intel just has so many more resources at their disposal. The company actually faces much tougher competition from companies outside the US. Samsung and TSMC are great companies in their own rights, but do somewhat different things. I’m not going to go too deep into this today, but know I am watching Intel very closely for now.

Medifast (MED)- As someone who was born and raised in Baltimore, I have a sweet spot for any local company. Medifast is one of the few public companies still located within city borders, so I like to check in on them. With a renewed focus, Medifast has grown quickly these last few years. Revenue has grown over 2.5x over the last 5 years.  Their financials look very strong, the company holds zero dollars of debt on their balance sheet. Any company able to grow quickly without having to take on a single dollar of debt is impressive in my book.

I am a little cautious about investing in this company however. I wouldn’t go as far as calling Medifast a pyramid scheme, but at first glance I would say they have pyramid like tendencies. Most of Medifast’s growth has come from the Optavia brand. Optavia is a multi level marketing company selling weight loss products. Their model works through having members sign up as coaches, who then make money selling products to other members. Perhaps this is all just a clever marketing scheme, but it sounds a bit fishy to me. Unless I can understand what differentiates Optavia from a pyramid scheme, I’ll be staying away.

As always, thank you all for taking the time to read! I hope you take some time and update your watchlist. If you find any companies I might be interested in, please send them my way. You can follow me on Twitter @TheGarpInvestor.