The Top 10 List for 2021

Professional Sports in a Covid World

I wanted to start this post by repeating something I discussed in my top ten lists in 2017, 2018 and 2020 which I learned while at Sanford Bernstein in my Wall Street days: “Owning companies that have strong competitive advantages and a great business model in a potentially mega-sized market can create the largest performance gains over time (assuming one is correct).” It does make my stock predictions somewhat boring (as they were on Wall Street where my top picks, Dell and Microsoft each appreciated over 100X over the ten years I was recommending them).

In the seven years we have been offering stock picks on this blog this strategy has worked quite well as the cumulative gains for my picks now exceeds 21X and the 7-year IRR is 55%. The two stocks that have been on the list every year, Tesla and Facebook, were at the end of 2020 at 77X and 11X, respectively, of the price I bought them in mid-2013. They both have been on our recommended list every year since but this is about to change.

In last year’s Top 10 list I pointed out that my target is to produce long-term returns at or above 26%. At that rate one would double their money every 3 years. Since the S&P has had compound growth of 10.88%/year for the past 7 years, and Soundbytes has been at 55%, I thought you might find it interesting to see how long a double takes at various levels of IRR and what multiple you would have after 10 years for each one.

Table: Compound Returns at Various Rates

The wonder of compounding is quite apparent in the table, but it also shows that patience is a virtue as holding the stocks of great companies longer can multiply your money significantly over time, while too many investors become inpatient and sell prematurely. In our last post of 2020 we outlined the thinking process to select great companies, but even great companies can have some periods where their returns are below par. Given that our picks were up an average of 259% last year, I’m back to a fearful mode that 2021 might be that period. Of course, I’m always fearful but sticking with great companies has worked out so far and trying to time when to sell and buy back those companies often leads to sub-optimization.

To some extent, over a 5-year period or longer, stock appreciation is correlated with a company’s growth. So, as I go through each of my 6 stock picks, I will discuss what that might mean for each company. With that in mind, as is my tendency (and was stated in my last post), I am continuing to recommend 5 of the 6 stocks from last year: Tesla, Zoom, Amazon, Stitch Fix and DocuSign. I am removing Facebook from the list and adding CrowdStrike. To be clear, I still believe Facebook will outperform the S&P (see Pick 7 below) but I also believe that over the next few years CrowdStrike and the 5 continuing stocks will experience greater appreciation.

2021 Stock Recommendations:

1. Tesla stock appreciation will continue to outperform the market (it closed last year at $706/share)

Tesla is the one stock in the group that is not trading in synch with revenue growth for a variety of reasons. This means it is likely to continue to be an extremely volatile stock, but it has so many positives in front of it that I believe it wise to continue to own it. The upward trend in units and revenue should be strong in 2021 because, in addition to continued high demand for the model 3:

  1. China Expansion: Tesla continues to ramp up production in China, the world’s largest market. In 2020 the company sold about 120,000 cars (which placed it a dominant number 1 in battery powered cars) there as its Giga Factory in Shanghai ramped up production. Trade Group China Passenger Car Association predicts that Tesla will sell as many as 280,000 vehicles there in 2021…an increase of about 133%. While that is significant growth it only would represent 20% of the number of battery powered vehicles forecast to be sold. The limitation appears to be production as the Shanghai factory is just nearing a volume of 5,000 vehicles per week. Tesla believes it can double that during this year. The Model Y has just been introduced in China and early press is calling it a major hit. Together with the Model 3, I believe this positions Tesla to be supply constrained. Should the company increase production earlier in the year, it has the opportunity to sell more than the forecast 280,000 vehicles. What is also important to note, is Tesla seems to be making greater profits on sales of its cars in China than in the U.S so as China becomes a larger portion of the mix Gross Margin could increase.
  • European Factory: Tesla has a cost disadvantage in Europe as its cars are not currently built there. So, while it established an early lead in market share, as others have launched battery powered vehicles at lower prices Tesla lost market share. That should all change when its Berlin Giga Factory begins production in July, 2021. This coupled with the Model Y introduction (it will be built in the Berlin factory) should mean a notable increase in sales as Europe returns to more normal times.
  • Model Y introduction: The Model Y, launched in early 2020 in the U.S., is already selling about 12,000 units a month here. This exceeds sales of crossover vehicles from every major brand (per GCBC which uses VIN reporting to calculate its numbers). It is expected to start being delivered in China in February.
  • Cybertruck: The Cybertruck (see our graphic here) was introduced to extremely mixed reactions. Traditionalists tended to hate it due to its radical departure from what they have come to expect for a pickup truck from companies like Ford, Toyota, etc. But it rang a cord with many and pre-orders are now up to 650,000 units according to Finbold. To give perspective on what this means, it is 30% higher than the total number of vehicles Tesla sold in 2020.  While a portion of these orders could be cancelled as they only required a $100 deposit, the magnitude does imply significant incremental demand when Tesla launches in this category. The launch is expected late this year.
  • Roadster: Tesla has plans to re-introduce a Roadster in 2021. You may recall that the first Tesla’s were sports cars and are now collectors’ cars mostly valued between $50,000 and $70,000 but now the last one built, having about 200 miles on it is up for sale at $1.5 million. This time around it will make it an ultra-premium vehicle in specifications and in price. The base price Tesla has indicated starts at $200,000. A “Founders Series” will be $50,000 higher (with only 1,000 of those available). At those prices, gross margins should be quite high.  The range Tesla initially indicated for this car was 620 miles and the speed from 0 to 60 of 1.9 seconds which would be much quicker than the McLaren 570S gas powered auto.
  • Tesla Semi: of all the vehicle categories that would benefit from being battery powered I believe the Semi is on top. That is because cost of ownership is one of the highest priorities for vehicles used in commerce. And Tesla claims that their semi will offer the lowest cost of ownership due to economic cost of fuel, less maintenance required as it has fewer parts, and easier repairs. According to Green Car Reports Musk has said it will begin being produced in 2021. Even assuming that Elon’s optimism is off, it appears that it could hit the market in early 2022. Once a definite date and specs are public, sales forecasts for Tesla could rise in 2022.

I’ve taken more time than usual to review my thoughts on Tesla as its astounding stock appreciation in 2020 make it vulnerable to stock pullbacks of some magnitude from time to time. But, its potential to achieve meaningful share of overall auto sales as various geographies shift to battery powered vehicles gives it the potential to achieve high growth in revenue for many years to come.  

2. DocuSign stock appreciation will continue to outperform the market (it closed last year at $222/share)

DocuSign is the runaway leader in e-signatures facilitating multiple parties signing documents in a secure, reliable way for board resolutions, mortgages, investment documents, etc. Being the early leader creates a network effect, as hundreds of millions of people are in the DocuSign e-signature database. The company has worked hard to expand its scope of usage for both enterprise and smaller companies by adding software for full life-cycle management of agreements. This includes the process of generating, redlining, and negotiating agreements in a multi-user environment, all under secure conditions. On the small business side, the DocuSign product is called DocuSign Negotiate and is integrated with Salesforce.

DocuSign was another beneficiary of the pandemic as it helped speed the use of eSignature technology. The acceleration boosted revenue growth to 53% YoY in Q3, 2021 (the quarter ended on October 31, 2020) from 39% in Fiscal 2020.  Total customers expanded by 46% to 822,000. At the same time Net Retention (dollars spent by year-ago customers in Q3 FY21 vs dollars spent by the same customers a year earlier) was 122% in the quarter. Non-GAAP gross margin remained at 79% as increased usage per customer (due to the pandemic) had minimal impact on cost. Given DocuSign’s strong Contribution Margin, operating profits increase faster than revenue and were up to $49 million from $17 million in the year ago quarter. What has happened represents an acceleration of the migration to eSignature technology which will be the base for DocuSign going forward. Once a company becomes a customer, they are likely to increase their spend, as evidenced by 122% Net Revenue growth. Finally, competition appeared to weaken as its biggest competitor, Adobe, lost considerable ground. This all led to a sizable stock gain of 200% to $222/share at year end.  In my view, the primary risk is around valuation but at 50% growth this gets mitigated as earnings should grow much faster than revenue. I continue to believe the stock will appreciate faster than the S&P.

3. Stitch Fix Stock appreciation will continue to outperform the market (it closed last year at $58.72/share)

Stitch Fix offers customers, who are primarily women (although its sales in Men’s clothing is rising), the ability to shop from home by sending them a box with several items selected based on sophisticated analysis of their profile and prior purchases. The customer pays a $20 “styling fee” for the box which can be applied towards purchasing anything in the box. The company is the strong leader in the space with revenue at nearly a $2 billion run rate. The stock had a strong finish to 2020 after declining substantially earlier in the year due to Covid negatively impacting performance. This occurred despite gaining market share as people simply weren’t buying a normal amount of clothes at the onset of the pandemic. When revenue growth rebounded in the October quarter to 10% YoY and 7% sequentially the stock gained significant ground and closed the year up 129%.

Stitch Fix continues to add higher-end brands and to increase its reach into men, plus sizes and kids. Its algorithms to personalize each box of clothes it ships keeps improving. It appears to be beyond the worst days of the pandemic and expects revenue growth to return to a more normal 20-25% for fiscal 2021 (ending in July). This is partially due to easy comps in Q3 and Q4 and partly due to clothing purchase behavior improving. The company will also be a beneficiary of a number of closures of retail stores.

Assuming it is a 20-25% growth company that is slightly profitable, it still appears under-valued at roughly 3X expected Q2 annualized revenue. As a result, I continue to recommend it.

4. Amazon stock will outpace the market (it closed last year at $3257/share).

Amazon shares increased by 76% last year while revenue in Q3 was up 37% year over year (versus 21% in 2019). This meant the stock performance exceeded revenue growth as its multiple of revenue expanded in concert with the increased revenue growth rate. Net Income grew 197% YoY in the quarter as the leverage in Amazon’s model became apparent despite the company continuing to have “above normal” expenditures related to Covid. We expect the company to continue at elevated revenue and earnings growth rates in Q4 and Q1 before reaching comps with last year’s Covid quarters. Once that happens growth will begin to decline towards the 20-25% level in the latter half of 2021.

What will remain in place post-Covid is Amazon’s dominance in retail, leading share in Web Services and control of the book industry. Additionally, Amazon now has a much larger number of customers for its Food Services than prior to the pandemic. All in all, it will likely mean that the company will have another strong year in 2021 with overall growth in the 25-30% range for the year and earnings growing much faster. But remember, the degree earnings grow is completely under Amazon’s control as they often increase spend at faster rates than expected, especially in R&D.

5. Zoom Video Communications will continue to outperform the market (it closed last year at $337/share)

When I began highlighting Zoom in my post on June 24, 2019, it was a relatively unknown company. Now, it is a household name. I’d like to be able to say I predicted that, but it came as a surprise. It was the pandemic that accelerated the move to video conferencing as people wanted more “personal contact” than a normal phone call and businesses found it enhanced communications in a “work at home world”. Let me remind you what I saw in Zoom when I added it to the list last year, while adding some updated comments in bold:

  1. At the time, Revenue retention of business customers with at least 10 employees was about 140%. In Q3, FY 2021 revenue retention of business customers was still 130% despite pandemic caused layoffs.
  2. It acquires customers very efficiently with a payback period of 7 months as the host of a Zoom call invites various people to participate in the call and those who are not already Zoom users can be readily targeted by the company at little cost. Now that Zoom is a household name, acquiring customers should be even less costly.
  3. At the time, Gross Margins were over 80% and I believed they could increase. In Q3, GM had declined to 68% as usage increased dramatically and Zoom made its products available to K-12 schools for free. Given that students were all mostly attending school virtually, this is a major increase in COGs without associated revenue. When the pandemic ends gross margins should return close to historic levels – adding to Zoom profits. 
  4. The product has been rated best in class numerous times
  5. Its compression technology (the key ingredient in making video high quality) appears to have a multi-year lead over the competition
  6. Adding to those reasons I noted at the time that ZM was improving earnings and was slightly profitable in its then most recent reported quarter. With the enormous growth Zoom experienced it has moved to significant profitability and multiplied its positive cash flow.

While ZM stock appreciated 369% in 2020, it actually was about equal to its revenue growth rate in Q3 2020, meaning that the price to revenue was the same as a year earlier before despite:

  • Moving to significant profitability
    • Becoming a Household name  
    • Having a huge built-in multiplier of earnings as schools re-open

6. CrowdStrike will outperform the market (it closed 2020 at $211/share and is now at 217.93)

When I evaluate companies, one of the first criteria is whether their sector has the wind behind its back. I expect the online security industry to not only grow at an accelerated pace but also face an upheaval as more modern technology will be used to detect increased attacks from those deploying viruses, spam, intrusions and identity theft. I suspect all of you have become increasingly aware of this as virus after virus makes the news and company after company reports “breaches” into their data on customers/users.

The U.S. cyber security market was about $67 billion in 2019 and is forecast to grow to about $111 billion by 2025 (per the Business Research Company’s report). Yet Cloud Security spend remains at only about 1.1% of total Cloud IT spend (per IDC who expects that percent to more than double). CrowdStrike is the player poised to take the most advantage of the shift to the cloud and the accompanying need for best-in-class cloud security. It is the first Cloud-Native Endpoint Security platform. As such it is able to monitor over 4 trillion signals across its base of over 8500 subscription customers. The companies leading technology for modern corporate systems has led to substantial growth (86% YoY in its October quarter). It now counts among its customers 49 of the Fortune 100 and 40 of the top global 100 companies.

Tactically, the company continues to add modules to its suite of products and 61% of its customers pay for 4 or more, driving solid revenue retention. The company targets exceeding 120% of the prior year’s revenue from last year’s cohort of customers. They have succeeded in this for 8 quarters in a row through upselling customers combined with retaining 97% – 98% of them. Because of its cloud approach, growing also has helped gross margins grow from 55% in FY 18 to 66% in FY 19 to 72% in FY 20 and further up to 76% in its most recent quarter. This, combined with substantial improvement in the cost of sales and marketing (as a % of revenue) has in turn led to the company going from a -100% operating margin in Fiscal 2018 to +8% in Q3, FY21. It seems clear to me that the profit percentage will increase dramatically in FY22 given the leverage in its model.  

Non-Stock Picks for 2021

7. Online Advertising Companies will Experience a Spike in Growth in the Second Half of 2021

The pandemic hit was devastating for the travel industry, in-person events and associated ticket sellers, brick and mortar retailers and clothing brands.  Rational behavior necessitated a dramatic reduction of advertising spend for all those impacted. U.S. advertising revenue declined by 4.3% to $213 billion, or around 17% according to MagnaGlobal, if one excludes the jump in political advertising (discussed in our last post), with Global spend down 7.2%. That firm believes digital formats grew revenue about 1% in 2020 (with TV, radio and print declining more than average). Digital formats would normally be up substantially as they continue to gain share, so the way to think about this is that they experienced 10-20% less revenue than would have occurred without Covid.

Assuming things return to normal in H2 2021, digital advertising will continue to gain share, total industry revenue will be higher than it would have been without Covid (even without the increased political spending in 2020) and comps will be easy ones in H2 of 2021.  While there will not be major political spending there could be Olympic games which typically boost ad spend. So, while we removed Facebook from our 6 stock picks, it and other online players should be beneficiaries.

8. Real Estate will Show Surprising Resiliency in 2021

The story lines for Real Estate during the pandemic have been:

  1. The flight to larger outside space has caved urban pricing while driving up suburban values
  2. Commercial real estate pricing (and profits) is collapsing, creating permanent impairment in their value for property owners with post-pandemic demand expected to continue to fall

My son Matthew is a real estate guru who has consulted to cities like New York and Austin, to entities like Burning Man and is also a Professor of Real Estate Economics at NYU. I asked him to share his thoughts on the real estate market.

Both Matthew (quoted below) and I disagree with the story lines. I believe a portion of the thinking regarding commercial real estate pricing relates to the collapse of WeWork. That company, once the darling of the temporary rental space, had a broken IPO followed by a decline in value of nearly 95%. But the truth is that WeWork had a model of committing to long term leases (or purchasing property without regard to obtaining lowest cost possible) and renting monthly. Such a company has extreme risk as it is exposed to downturns in the business cycle where much of their business can disappear. Traditional commercial property owners lease for terms of 5 to 25 years, with 10-15 years being most common, thus reducing or even eliminating that risk as leases tend to be across business cycles. The one area where both Matthew and I do believe real estate could be impacted, at least temporarily, is in Suburban Malls and retail outlets where Covid has already led to acceleration of bankruptcies of retailers a trend I expect to continue (see prediction 10).

The rest of this prediction is a direct quote from Matthew (which I agree with).

“Real estate in 2021 will go down as the year that those who do not study history will be doomed to repeat it. The vastly overblown sentiments of the “death of the city” and the flight to the suburbs of households and firms will be overshadowed by the facts. 

In the residential world, while the market for rentals may have somewhat softened, no urban owners have been quick to give up their places, in fact, they turned to rent them even as they buy or rent roomier locations within the city or additional places outside the cities, driving up suburban prices more quickly. In fact, even in markets such as NYC, per square foot housing sale prices are stable or rising. US homebuilding sentiment is the highest in 35 years, with several Y/Y growth statistics breaking decades long records leading up to a recent temporary fizzle due to political turmoil. 

The commercial office world, which many decry as imminently bust due to the work at home boom, has seen a slowdown of new leases signed in some areas. But because most commercial office leases are of a 10–15-year term, a single bad year has little effect. While some landlords will give concessions today for an extended term tomorrow, their overall NPV may remain stable or even rise. In the meantime, tech giants like Amazon are gobbling up available space in the Seattle and Bellevue markets, and Facebook announced a 730,000 square foot lease in midtown Manhattan late in the year. In the end, the persistence of cities as clusters of activity that provide productivity advantages to firms and exceptional quality of life, entertainment options, restaurants and mating markets to individuals will not diminish. The story of cities is the story of pandemic after pandemic, each predicting the death of the city and each resulting in a larger, denser, more successful one. 

The big story of real estate in 2021 will be the meteoric rise of industrial, which began pre-COVID and was super charged as former in-person sales moved to online and an entire holiday season was run from “dark stores” and warehouses. The continual build out of the last mile supply chain will continue to lower the cost of entry for retailers to accelerate cheaper delivery options. This rising demand for industrial will continue the trend of the creation of “dark stores” which exist solely as shopping locations for couriers, Instacart, Whole Foods and Amazon. Industrial is on the rise and the vaccine distribution problems will only accelerate that in 2021.”

9. Large Brick and Mortar Retailers will continue their downward trend with numerous bankruptcies and acquisitions by PE Firms as consumer behavior has permanently shifted

While bankruptcies are commonplace in the retail world, 2020 saw an acceleration and there was a notable demise of several iconic B&M (Brick & Mortar) brands, including:

It is important to understand that a bankruptcy does not necessarily mean the elimination of the entity, but instead often is a reorganization that allows it to try to survive. Remember many airlines and auto manufacturers went through a bankruptcy process and then returned stronger than before. Often, as part of the process, a PE firm will buy the company out of bankruptcy or buy the brand during the bankruptcy process. For example, JC Penny filed for bankruptcy protection in May, 2020 and was later acquired by the Simon Property Group and Brookfield Property Partners in September, 2020. Nieman Marcus was able to emerge from bankruptcy protection without being acquired. However, in both cases, reorganizing meant closing numerous stores.

There are many who believe things will: “go back to normal” once the pandemic ends. I believe this could not be further from the truth as consumer behavior has been permanently impacted. During the pandemic, 150 million consumers shopped online for the first time and learned that it should now be part of how they buy. But, even more importantly, those who had shopped online previously became much more frequent purchasers as they came to rely on its advantages:

  1. Immediate accessibility to what you want (unlike out of stock issues in Brick and Mortar retail)
  2. Fast and Free shipping in most cases
  3. A more personalized experience than in store purchasing

As older Brick & Mortar brands add online shopping to their distribution strategy, most are unable to offer the same experience as online brands. For example, when you receive a package from Peloton the unboxing experience is an absolute delight, when you receive one from Amazon it is perfectly wrapped. On the other hand, I have bought products online from Nieman Marcus, an extremely high-end retailer, and the clothes seemed to be tossed into the box, were creased and somewhat unappealing when I opened the box. Additionally, a company like Amazon completely understands the importance of customer retention and its support is extraordinary, while those like Best Buy that offer online purchasing fall far of the bar set by Amazon.

What that all means is that many Brick and Mortar retailers will not solve their issues:

  • Adding more of an online push will not be enough
    • Customers that have experienced the benefits of online purchasing will continue to use it in much greater amounts than before the pandemic
    • Ecommerce will continue to take share from Brick and Mortar stores
    •  

As a result, we believe that in 2021 the strain on physical retail will continue, resulting in many more well-known (and lesser known) store chains and manufacturing brands filing for bankruptcy as the dual issues of eCommerce and of the pandemic keeping stores closed and/or operating at greatly diminished customer traction throughout most of the year. Coming on the heels of a disastrous 2020 it will be harder for many of them to even emerge from bankruptcy after reorganizing (including closing many stores). 

10. The Warriors will make the playoffs this Year

I couldn’t resist including one fun pick. We did speak about this in our last post but wanted to include it as an actual 2021 pick. Many pundits had the Warriors as dead before this season began once Klay Thompson was injured. And, of course, more piled on when the team lost its first 2 games by large margins. But they were mis-analyzing several significant factors:

  • Steph Curry is still Steph Curry at his peak no matter who the supporting cast
  • Andrew Wiggins is a superior talent who has the ability to shine on both offense and defense now that he is no longer in a sub-optimal Minnesota environment
  • Kelly Oubre Jr is also talented enough to be a great defender. His offense, while poor so far, is well above average and over the course of the season that should show well
  • Draymond Green is in his prime and remains one of the top defenders in the league. He is also a great facilitator on the offensive end of the floor.
  • James Wiseman is a phenomenon with the talent to be a star. As the season progresses, I expect him to continue to get better and become a major factor in Warrior success
  • Eric Pascal was on the all-rookie team last year and has gotten better

It is clear that the team needs more games to get Curry and Green back into peak playing condition, Wiseman to gain experience and the Warriors to become acclimated to playing together. They have started to show improved defense but still need time to develop offensive rhythm. I expect them to be a major surprise this year and make the playoffs.

SoundBytes

  • Please Wear A Mask: I recently read a terrific book describing the 1918 flu pandemic called The Great Influenza by John Barry. That pandemic was much deadlier than the current one, with estimates of the number of people it killed ranging from 35 million to 100 million when the world population was less than 25% of what it is today. What is so interesting is how much the current situation has replicated the progress of that one. One of the most important conclusions Barry draws from his extensive study of the past is that wearing a mask is a key weapon for reducing the spread.

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