The year 2020 has been truly unprecedented. In the short span of a year, a contagious virus has been declared a pandemic, infecting nearly 70 million people and killing almost 1.6 million globally. Countries went on lockdowns and global travel evaporated, leading to job losses and unemployment skyrocketing by the millions. A large part of the remaining working population had to adapt to working from home instead of a centralized workplace. Vaccines were concocted in record time with governments granting emergency use approval across various parts of the world. We are in the depths of a recession, yet the US financial markets seem to make no indication of this, with major indices breaking through their All-Time-Highs week after week.
The whirlwind of events and somewhat disjointed behaviour of the stock markets forces a re-think of one’s beliefs and values around the topics of financial markets and investing methodologies. Unabashedly loss-making companies have seen their share prices bid up multi-fold, with the likes of Sea Limited (SE) and CrowdStrike Holdings (CRWD) returning 397% and 264% respectively year-to-date. Even the famous Warren Buffett – whose conservative value-investing style I have largely modelled myself after – seemed to have succumbed to the growth faction with his latest high-profile bet in Snowflake Inc. (SNOW), a similarly loss-making company trading at valuations uncharacteristic of typical Buffett buys.
My investment journey thus far has taught me much. From a naive young investor studying only Earnings-Per-Share (EPS) and Book-Value-Per-Share (BVPS) trends, I have evolved to look at other financial metrics which are crucial in helping to determine the investment-worthiness for a given company. Yet, the developments of 2020 has brought me to uncharted waters, fuelling much self-doubt and challenging my long-standing notions of what makes a good investment. As someone who has eschewed loss-making companies, I find myself forced to scrutinize my strategy against the backdrop of these hypergrowth portfolios making gains hand over fist.
My Investment Strategy re-visited
The key pillars of my investment strategy are:
- Identify Growth Industries
- Look for companies with proven financial track record
- Hone in on the companies trading at reasonable valuations. The rest goes to the watchlist.
Essentially, what I try to do is to identify value amidst growth. By keeping a watchful eye on Price-to-Earnings (PE), Price-to-Book (PB), and Price-to-Free-Cash-Flow (PFCF) metrics, I cautiously avoid ‘overpaying’ for stocks by committing a purchase only when prices are at or below historical valuations.
If this sounds like an oxymoron to you, well, maybe it is. The truth is, these ‘growth’ stocks trade above historical valuations for the most part, and prices only fall to the ‘buy zone’ very ephemerally during times of crises. This means that I find myself sitting on the sidelines most of the time, waiting and watching woefully as markets trend higher while I miss out on all the fun.
Using the example of Alphabet Inc. (GOOGL) and assuming this company passes criteria 1 & 2 stated above, let us do a little exercise and try to spot buying opportunities using the charts that my computer program has generated.
With the dashed lines interpreted as the ‘historical average’ valuations over past 7 years, we observe that the share price of Alphabet Inc. has on rare occasions fallen substantially enough such that the PE/ PB/ PFCF ratios deem it a reasonable buy. The circled areas coincide with the height of US-China trade war, and most recently (not marked in chart above) this occurred again during the pandemic stock market rout in March 2020. As you can see, buying opportunities are few and far between using this investment strategy. I was fortunate enough to buy into Alphabet Inc. in March and its shares have soared almost ~70% since.
How has my portfolio performed, you ask? Not great, truth be told.
From inception in May-2018 to-date, we’re looking at a meagre 11.2% unrealized gain. Comparatively, we see that both the Vanguard Growth (VOOG) and Vanguard Value (VOOV) ETFs have outperformed my own stock-picking endeavours. If I take a step back from bashing myself, I’d concede that my portfolio had a major ‘value tilt’ in its early days and only started looking at growth seriously from early this year. Convenient excuses aside, the fact stands that I have indeed been a sub-par fund manager.
Also from the above chart, one can see that Growth Investing has indeed outperformed Value Investing both pre- and post-pandemic in this 3-year timeframe by a factor of 2.6x. This is a significant deviation from a longer timeframe comparison spanning a century, where Value’s 1,344,600% returns has outstripped Growth’s 626,600% returns since 1926. Therein begs the question: Is Value Investing dead?
The Value Trap vs Growth At Any Cost?
While Value Investors chase bargain deals in the attempt to ‘buy a dollar for 50 cents’, one ought to be careful not to fall into a value trap. One possible example of this could be Singapore Airlines Limited (C6L.SI), which was running a consistently negative Free Cash Flow and stagnant per-share Revenue and Earnings even pre-pandemic. Compare this against similarly-sized (based on annual revenues) Southwest Airlines Co. (LUV) in the charts below. I rest my case.
As the endless debate of Growth versus Value rages on, my personal experience thus far tells me to steer away from a full-out value setup. To doggedly chase value, without adequate consideration of macro worldly developments, seems to be a fool’s errand. Case in point is Singapore Press Holdings (T39.SI) and the decreasing relevance of printed newspapers, leading to rapid deterioration of business fundamentals since the advent of digital alternatives.
On the other hand, pursuing a ‘Growth At Any Cost’ approach the likes of some hypergrowth companies seem to be a risky proposition in itself too. When would these companies ever turn a profit, if at all? Should logic still have a place in today’s erratic markets, an investor would naturally expect portfolio companies to be profitable eventually. Unless, of course, it’s all a dangerous game of ‘pass the parcel’ and the final recipient ends up with a boatload of worthless shares and a painful lesson learnt.
A Middle Ground
“You will go most safely in the middle.”Publius Ovidius Naso
In the wise words of Roman poet Publius Ovidius Naso, “You will go most safely in the middle“. Where I see myself treading is in neither extremities, but in the middle path where I seek to pay reasonable prices for Growth companies. This strategy has worked for me in 2020 and is what I feel most comfortable with. At the same time, I’ve learnt not to quickly dismiss loss-making hypergrowth companies, but instead keep a lookout for early signs of profitability and possible investment opportunities.
2021 And Beyond
Moving into 2021, I am cautious of governments’ monetary policies and the possible devaluation of currencies due to unrelenting fiscal stimulus in many parts of the world. In the US, the Federal Reserve has created an additional 3 trillion dollars of liquidity in 2020 alone to combat the pandemic-induced recession. All these excess cash has to go somewhere and they often wind up chasing the limited assets of this world, leading to broad-based inflation across various asset classes.
Detractors claim that the Central Banks can easily undo the excess capital once all these blows over, but will they have the courage to do what is ‘right‘ over what is ‘popular‘? After all, a contractionary monetary policy can cause financial hardship for some citizens whose votes – directly or indirectly – policymakers chase.
If we believe in this premise, one should avoid holding too much cash – which depreciates over time relative to assets – and buy into into financial instruments that can ride the inflationary wave. On that front, I reckon some of Singapore’s Real Estate Investment Trusts (REITs) are really sensible options that can benefit from a low interest rate environment and excess liquidity in the markets.
What are your thoughts to the above? If this post resonated with you, feel free to like, comment, and share with your friends! Thanks for reading!