Top Ten List for 2023

January 30, 2023 Mike Kwatinetz covid-19, Economics, Golden State Warriors, Predictions Predictions, Stocks

2022 was one of the worst years in the past 50 for the stock market in general, and for my stocks in particular. There are multiple ways to look at it. On the one hand I’m mortified that stocks that I selected have declined precipitously not only impacting my personal investment portfolio but also those of you who have acted on my recommendations. On the other hand, I believe this creates a unique opportunity to invest in some great companies at prices I believe are extremely compelling.

What went wrong for my stock picks in 2022? I have always pointed out that I am not amongst the best at forecasting the market as a whole but have been very strong at selecting great companies which over the long term (5 years or more) typically have solid stock appreciation if their operating performance is consistently good. But even great company’s stock performance can be heavily impacted in any given year by market conditions. Two key drivers of negative market conditions in 2022 were the huge spike in inflation coupled by the Fed raising rates to battle it. Inflation peaked at 9.1% in 2022. To put this in perspective, in the 9 years from 2012 to 2020, inflation was between 0.12% and 2.44% with 6 of the years below 2.0%. It began to increase in 2021 (up to 4.7%) but many thought this was temporary due to easing of the pandemic. When the rate kept increasing in the first half of 2022 the Feds began to act aggressively. A primary weapon is increasing the Fed Rate which they did 7 times in 2022 with the total increase of 4.25% being the largest amount in 27 years.

When rates increase the market tends to decline and high growth stocks decline even faster. So, the big question in 2023 is whether the expected additional rate increases projected at just under 1% for the year (which theoretically is built into current share prices) is enough for The Fed. In November, inflation was down to 7.11% and decreased further in December to 6.45%. If inflation continues to ease, The Fed can keep rate hikes in line with or below their stated target and market conditions should improve.

Of course, there is another issue for bears to jump on – the potential for a recession. That is why the December labor report was comforting. Jobs growth remained solid but not overly strong growing at 247,000 for the prior three months. This was substantially lower then where it had been at the end of 2021 (637,000 in Q4). While jobs growth of this amount might lead to wage growth of substance, the growth in December was a fairly normal 0.3%. If this persists, the theory is that inflation will moderate further. Additionally, more and more companies are announcing layoffs, particularly in the Tech sector.

I pointed out above that I am not a great forecaster of economics or of the market as a whole so the above discussion may not mean inflation moderates further, or that Fed Rate hikes stay below a one percent total in 2023, or that we avoid a deep recession – all of which could be further negatives for the market. But given where stocks now sit, I expect strong upside performance from those I recommend below.

I also want to mention that given the deep decline in the market, 2022 was extremely busy for me and the decline in blogs produced has been one of the consequences. I’ll try to be better in 2023! I am going to publish the recap of 2022 picks after the new Top Ten blog is out. Suffice it to say the recap will be of a significant miss for the stocks portion of the forecast, but that means (at least to me) that there is now an opportunity to build a portfolio around great companies at opportune pricing (of course I also thought that a year ago).

Starting in mid-2021 the Tech sector has taken a beating as inflation, potential interest rate spikes, the Russian threat to the Ukraine (followed by an invasion), a Covid jump due to Omicron and supply chain issues all have contributed to fear, especially regarding high multiple stocks. What is interesting is that the company performance of those I like continues to be stellar, but their stocks are not reflecting that.

For 2023, the 6 stocks I’m recommending are Tesla(TSLA), Amazon (AMZN), CrowdStrike (CRWD), Shopify (SHOP), Data Dog (DDOG) and The Trade Desk (TTD). The latter two replace Zoom and DocuSign. While I have removed Zoom and DocuSign from this year’s list, I still expect them to appreciate but their growth rates are substantially below their replacements.

In the introduction to my picks last year, I pointed out that over time share appreciation tends to correlate to revenue growth. This clearly did not occur over in the last 12 months or the last 24 months as illustrated in Table 1.

Note: 2022 for CRWD is actually FY 23 estimated revenue as year end is Jan 31. 2022 revenue uses analyst consensus estimates for Q4 which has on average been lower than actual revenue. Averages are unweighted.

The average revenue gain in 2022 (FY 23 for CRWD) reported by these companies (using analyst estimates for Q4) was nearly 38% while the average stock in the group was down 58%. In 2021 all the stocks except CRWD were up but only Data Dog had higher appreciation than its revenue growth. But in 2022 Data Dog declined significantly despite over 60% revenue growth. If we look at the two-year combined record the average stock in this group had a revenue increase of over 116% with three of the six increasing revenues by over 150%! Yet, on average, share performance for the group was a decline of over 48%. It should also be noted that Amazon’s major profit driver, AWS grew much more quickly than the company as a whole. Another point to highlight is that the strength of the dollar meant that US dollar revenue growth was lower than actual growth on a neutral dollar basis.

While over time I would expect share performance to be highly correlated to revenue growth, clearly that has not been the case for the past 24 months. I look at the revenue multiple as a way of measuring the consistency of valuation. Of course, these multiples should be lower as a company’s growth rate declines but looking at these 6 companies the amount of the decline is well beyond anything usual. Certainly, the pandemic causing wild swings in growth rates is partly responsible in the case of Amazon and Shopify but the other 4 companies have continued to experience fairly usual growth declines for high growth companies and all remain at strong growth levels.

Table 2 shows the change in revenue multiples in 2021 and in 2022 and then shows the 2-year change as well. Over the 2-year period every one of these stocks experienced a multiple decline of at least 60% with three of them declining more than 80%. Even if one assumes that valuations were somewhat inflated at the beginning of 2021 it appears that they all have substantial upside from here especially given that they are all growth companies. Which means if the multiples stabilize at these levels the stocks would appreciate substantially in 2023. If the multiples returned to half of where they were on December 31, 2020, the appreciation would be pretty dramatic.

Notes: 1. CRWD numbers are for fiscal years 2022 and 2023 ending January 31. 2. For Q4 revenue for each company we used Analyst average estimates. 3. All averages are calculated on an unweighted basis.

Given the compression in revenue multiples across the board in tech stocks, the opportunity for investing appears timely to me. Of course, I cannot predict with certainty that the roughly 75% average decline in revenue multiple among these stocks represents the bottom but we never know where the bottom is.

2022 Stock Recommendations

(Note: as has been our method base prices are as of December 31, 2022)

1. Tesla will outperform the market (it closed 2022 at $123.18/share)

Despite revenue growth of over 50%, Tesla was one of the worst stocks in 2022. While Q4 financials have yet to be reported, the company car sales were announced as 405,278 in the quarter up over 31%. For the year, the company shipped over 1.3 million vehicles up 40% over 2021. These volumes are still without Tesla being in the biggest category of vehicles, pickup trucks. Revenue in Q4 is expected to be up more than units with an over 35% increase the analyst consensus (note: Tesla reported last night, and revenue was up 37%).

Earnings have been increasing faster than revenue and consensus earnings estimates for 2022 is over $4 (it came in at $4.07 up 80%), meaning the stock is now trading at about 30 X 2022 earnings. This is a very low level for a high growth company.

One concern for investors is the decrease in the Tesla backlog. At year end it was at about 44 days of production (or roughly ½ of units sold in Q4. While there are many elements to consider there is a concern that it will be difficult for Tesla to maintain an above 30% vehicle growth rate in 2023. But there are several factors that indicate that such a concern is potentially incorrect:

The US began again offering a $7500 tax credit for electric vehicles starting January 1, 2023. This clearly caused many to postpone their purchase to get the credit. Tesla attempted to offset this by offering a similar discount in the US late in 2022 but it is likely that demand was seriously impacted. In early 2023 Tesla lowered prices to insure more of its units qualified for the credit. While this price decrease lowers average AOV from Q4 it still left most of its units at or above prices one year ago as Tesla had raised prices multiple times in 2022.
The Tesla CyberTruck has a wait list that exceeds 1.5 million vehicles, which if added to the backlog, would increase it to a full year of vehicles. But, of course, the company needs to get this into production to address these orders. Currently the company is expected to begin production around the middle of this year and get to high volume some time in Q4.
Tesla has an easy comp in Q2 since China shut down for much of Q2 2022.
The company now has the manufacturing capacity to increase volumes – the question will be parts supply and whether demand will be strong if the economy goes into a recession.

Since manufacturing capacity increased by the end of Q3, Q4 showed another strong sequential increase in units sold of nearly 18%. Once again demand was not an issue for the company as its order backlog, while lower than at its peak, remained at 6 weeks exiting the quarter. This does not include the estimated 1.5 million units in backlog for the Tesla CyberTruck which would put the total backlog at over one year of current production capacity. The current estimate for this vehicle going into production is roughly mid-year 2023.

Tesla has increased manufacturing capacity with Fremont and China at their highest levels ever exiting Q3, and Berlin and Texas in the early ramp up stage. Despite a reduction of its backlog, demand for its vehicles continues to increase. As you hear of new competition in the electric vehicle market keep in mind that Tesla share of the US market for all cars is still only about 3% and in China and Europe it remains under 2%. As the world transitions to electric vehicles, we expect Tesla’s share of all auto sales to rise substantially, even as it declines in total dominance of the electric vehicle market. It deserves re-emphasis: when the Cybertruck begins shipping, Tesla total backlog could exceed one year of units even assuming higher production. And the Cybertruck current backlog isn’t expected to be fulfilled until late 2027!

As we forecast in prior letters, Tesla gross margins have been rising and in Q3 remained the highest in the industry. While lower vehicle prices and increasing cost of parts will place some pressure on gross margins, we still believe they will continue to remain by far the highest of any auto manufacturer:

Tesla, like Apple did for phones, is increasing the high margin software and subscription components of sales;
The full impact of price increases was not yet in the numbers last year, so its price reductions have less impact than their percent of AOV and add-on sales are likely to offset a portion of the decreases;
As its new factories ramp, they will increase their efficiency; and
Tesla will have lower shipping cost to European buyers as the new Berlin factory reaches volume production.

In Q4, we believe the Tesla Semi was produced in very small volumes and limited production capacity will mean any deliveries will remain minimal during the next few quarters. However, given its superior cost per mile the Semi is likely to become a major factor in the industry. Despite its price starting at $150,000 its cost per mile should be lower than diesel semis. Given potential of up to $40,000 in US government incentives the competitive advantage over diesels will be even greater. The company is expecting to increase production to about 50,000 per year by some time in 2024 (which would represent potential incremental annual sales in the 8-10 billion range). While this is ambitious, the demand could well be there as it represents a single digit percent of the worldwide market for a product that should have the lowest cost/mile of any in the semi category.

The new version of the roadster is being developed but it’s unclear when it will be ready. Nevertheless, it will become another source of incremental demand at high margins. What this all points to is high revenue growth continuing, strong gross margins in 2023 and beyond, and earnings escalation likely faster than revenue growth. While revenue growth is gated by supply constraints it should still be quite strong. The high backlog helps assure that 2023, 2024 and 2025 will be high growth years. While the company has reduced pricing recently, the ability to sell greater dollars in software should help maintain strong AOV and gross margins

2. Crowdstrike (Crwd) will outperform the market (it closed 2022 at $105.29/share)

The most recently reported quarter for CrowdStrike, Q3 FY23 was another strong one as the pandemic had little impact on its results. Revenue was up 53% and earnings 135%. Existing customers continued to expand use of the company’s products driving Net Revenue Retention to exceed 120% for the 16th consecutive quarter. CrowdStrike now has over 59% of customers using 5 or more of its modules and 20% using at least 7 of its modules. Of course, the more modules’ customers use the bigger the moat that inhibits customer defection.

Older data security technology was focused primarily on protecting on-premises locations. CrowdStrike has replaced antivirus software that consumes significant computing power with a less resource-intensive and more effective “agent” technology. CrowdStrike’s innovation is combining on premise cybersecurity measures with protecting applications in the cloud. Since customers have a cloud presence, the company is able to leverage its network of customers to address new security issues in real time, days faster than was possible with older technology. While the company now has nearly 20 thousand subscription customers it is still relatively early in moving the market to its next gen technology. Given its leadership position in the newest technology coupled with what is still a modest share of its TAM the company remains poised for high growth.

High revenue growth coupled with 79% subscription gross margins, should mean earnings growth is likely to continue to exceed revenue growth for some time. In Q3 earnings grew 135%. While its stock is being penalized along with the rest of the tech market (its multiple of revenue declined by over 66% in 2022 and 80% in the past 2 years), its operational success seems likely to continue. Once pressures on the market ease, we believe CrowdStrike stock could be a substantial beneficiary.

3. Amazon will outperform the market (it closed 2022 at $84.00/share)

Amazon improved revenue growth in Q3 to 15% from 7% in Q2. In constant currency (taking out the impact of the increased strength of the dollar) its growth was 19% versus 10% in Q2. However, the company guidance for Q4 unnerved investors as it guided to Q4 revenue growth of 2-8% year/year and 4.6% higher in constant currency. Because AWS, which grew 27% y/y in Q3 is a smaller part of revenue in Q4 than other parts of the year, the weaker consumer growth can tend to mute overall growth in Q4. As the company heads into 2023 it should benefit from weaker comps and we expect revenue growth to improve from Q4. Of course, the Fed pushing up interest rates is likely to slow the economy and Analysts are currently predicting revenue growth of about 10% in 2023 (which would be higher in constant currency). But it’s important to understand that the profit driver for the company is AWS which generates nearly all the profits for the company. Even in a weaker economy we would expect AWS revenue to grow over 20%.

While Amazon is not the “rocket ship” that other recommendations offer, its revenue multiple has slipped by over 60% in the past 2 years. We believe improved growth coupled with smaller Fed increases should benefit the stock. One important side point is that the fluctuation in Rivian stock impacts Amazon earnings and Rivian was down quite a bit in Q4.

One wild card for the stock is whether its recent 20 for 1 stock split will lead to its being included in the Dow Jones Index. Because the index is weighted based on stock price Amazon could not be included prior to the split as its weight (based on stock price) would have been around 30% of the index. Given its share price post-split it is now a good fit. The Dow Index tries to represent the broad economy so having the most important company in commerce included would seem logical. Changes in the composition of the index are infrequent, occurring about once every 2 years, so even if it gets included it is not predictable when that will occur. However, should it occur, it would create substantial incremental demand for the stock and likely drive up the price of Amazon shares.

4. The Trade Desk (TTD) will outperform the market (it closed 2022 at $44.83/share)

TTD provides a global technology platform for buyers of advertising. In the earlier days of the web, advertisers placed their ads on sites that had a large pool of users that met their demographic requirements. These sites were able to charge premium rates. TTD and others changed this by enabling an advertiser to directly buy the demographic they desired across a number of sites. This led to lower rates for advertisers and better targeting. Now with the rise of Connected TV TTD applies the same method to video. By moving in this direction advertisers can value and price data accurately. Given its strength of relationships, TTD has become the leader in this arena. The company believes that we are early in this wave and that it can maintain high growth for many years as advertisers shift to CTV from other platforms that have been more challenged due to government regulations regarding privacy as well as Apple changes for the iPhone.

In Q3 The Trade Desk grew revenue 39% and earnings 44% as their share of the advertising market continued to increase. We believe TTD can continue to experience strong growth in Q4 and 2023. We also believe after having its revenue multiple contract 70% over the past 2 years the company can also gain back some of that multiple.

5. DataDog will outperform the market (it closed 2022 at $73.50/share)

Datadog is an observability service for cloud-scale applications, providing monitoring of servers, databases, tools, and services, through a SaaS-based data analytics platform. Despite growing revenue close to 60% and earnings about 100% its stock still declined about 59% in 2022 due to the rotation out of tech stocks driven by the large Fed Rate increases. The company remains in a strong position to continue to drive high revenue growth and even higher earnings growth going forward.

6. Shopify (Shop) will outperform the market (it closed at $34.71/share)

Shop, like Amazon, experienced elevated growth in 2020 and the first half of 2021. This was due to Covid keeping people out of stores (many of which weren’t even open) and resulted in revenue escalating 86% in 2020 from 47% in 2019. The rate tapered off to a still elevated 57% in 2021 with Q4 at 41%. The elevated comps resulted in a decline in growth to below normalized levels once consumers returned to Brick & Mortar stores. By Q2, 2022 year over year revenue growth had fallen to 16%. We expected growth to return to over 20% and potentially stabilize there. This occurred in Q3 as revenue growth improved to 22%. We believe Shopify can continue to achieve stable growth in the 20% range or higher in 2023 as long as the economy does not go into a deep recession. Shopify has established a clear leadership position as the enabler of eCommerce sites. Its market share is second to Amazon and well ahead of its closest competitors Walmart, eBay, and Apple. Net revenue retention for the company continues to be over 100% as Shopify has successfully expanded services it provides to its eCommerce business customers. Additionally, because successful eCommerce companies are growing, Shopify also grows its portion of the customer revenue it shares.

Because of the wild swing in growth due to Covid, Shop experienced the most extreme multiple compression of the 6 stocks we’re recommending, 79% last year and 84% over the past two years. This leaves room for the stock to appreciate far beyond its growth rate in 2023 if market conditions improve.

Non-Stock Specific Predictions

While I usually have a wide spectrum of other predictions, this time I wanted to focus on some pressing issues for my 3 predictions that are in addition to the fun one. These issues are Covid, inflation and California’s ongoing drought. They have been dominating many people’s thoughts for the past 3 years or more. The danger in this is that I am venturing out of my comfort zone with 2 of the 3. We’ll start with the fun prediction.

7. The Warriors will improve in the second half of the current season and make the Playoffs

I always like to include at least one fun pick. But unlike a year ago, when I correctly forecast that the Warriors would win the title, I find it hard to make the same pick this year. While I believe they can still win it, they are not as well positioned as they were a year ago. This is partly because a number of teams have gotten considerably better including Memphis, Denver, the Kings and New Orleans in the West (with the Thunder, an extremely young team appearing to be close) and the Celtics, Bucks, Nets and Cavaliers in the East. The Warriors, by giving up Otto Porter and Gary Payton II (GPII), and other experienced players, took a step backwards in the near term. I believe signing Divincenzo gives them a strong replacement for GPII. They will need Klay and Poole to play at their best and Kuminga to continue to progress if they are to have a stronger chance to repeat.

8. Desalination, the key to ending long term drought, will make progress in California

It’s hard to believe that California has not been a major builder of desalination plants given the past 7 years of inadequate rainfall. Despite the recent rainfall, which might bring reservoirs back to a normal state by summer, it appears to be a necessary part of any rational long-term plan. Instead, the state is spending the equivalent of over one desalination plant per mile to build a high-speed railway (HSR) ($200 million per mile and rising vs $80 million for a small and up to $250 million for a very large desalination plant). When voters originally agreed to help fund the HSR the cost was projected at $34 billion dollars. According to the Hoover Institute, the cost has grown to over triple that and is still rapidly rising. If I had my druthers, I would divert at least some of these funds to build multiple desalination plants so we can put the water crisis behind us. Not sure of how many are needed but it seems like 10 miles of track funding 10 larger plants would go a long way towards solving the problem. It is interesting that Israel has built plants and has an abundance of water despite being a desert.

9. Inflation will continue to moderate in 2023

The Fed began raising rates to combat inflation early in 2022, but it didn’t peak until June when it reached 9.1%. One trick in better understanding inflation is that the year over year number is actually the accumulation of sequential increases for the past 12 months. What this means is that it takes time for inflation to moderate even when prices have become relatively stable. Because the sequential inflation rates in the second half of the year have been much lower than in the first half, inflation should keep moderating. As can be seen from Table 3, the full year’s increase in 2022 was 6.26% (which is slightly off from the announced rate as I’ve used rounded sequential numbers). The magnitude of the increase was primarily due to the 5.31% increase from January 1 through June 30.

If the second half of the year had replicated this, we would be at over 11% for the year. However, the Fed actions have taken hold and in the second half of the year (July 1 – December 31) inflation was down to 0.90% or an annualized rate of under 2.0%. And between November 1 and December 31 we had complete flattening of sequential cost. What this indicates to me is that the likelihood of inflation moderating through June 30, 2023 is extremely high (no pun meant). If I were to guess where we would be in June, I’d speculate that the year/year increase will be between 1% and 3%.

10. Covid’s Impact on society in the US will be close to zero by the end of 2023

Covid has reached the point where most (roughly 70%) of Americans are vaccinated and we estimate that over 75% of those that aren’t have already been infected at some point and therefore have some natural immunity. This means about 92% of Americans now have some degree of protection against the virus. Of course, given the ongoing mutation to new forms of Covid (most recently to the Omicron version) these sources of immunity do not completely protect people and many who have been vaccinated eventually get infected and many who already had Covid got reinfected. However, if we study peak periods of infection there appears to be steady moderation of the number of infections.

Covid infections reached their highest peak in the US around January 2022 at a weekly rate of approximately 5 million new cases. It subsequently dropped steadily through May before rising to another peak, fueled by Omicron, in July 2022 at a weekly rate of about 1 million (an 80% peak to peak decrease). Again, it subsequently dropped until rising more recently to a post-holiday/winter peak in early January 2023 to a weekly count of under 500,000 (a peak-to-peak drop of over 50% from July).

While the progress of the disease is hard to forecast the combination of a more highly vaccinated population coupled with a high proportion of unvaccinated people now having some immunity from having contracted the disease seems to be leading to steady lowering of infection rates.

More importantly, death rates have declined even faster as lower infection rates have been coupled with milder cases and better treatments (due to vaccinations and natural immunity increases for the 50% of the population that have contracted the disease over the past 3 years). Despite the recent post-holiday spike, deaths from Covid were under 4,000 across the country (or about 0.001% of the population) in the most recent week reported. If the seasonal pattern follows last year, this will be a peak period. So, using this as being very close to the likely maximum rate per week, we can forecast that the annual death rate from Covid in 2023 will be between 100,000 and 200,000 Americans. This would put it between the 4th and 6th leading causes of death for the year with heart disease and Cancer the leading causes at over 600,000 each.

Given that most people have already significantly reduced use of masks and are visiting restaurants, department stores, theaters, sporting events, concerts and numerous other venues where people are quite close to each other, we believe the impact of Covid on the economy has faded and that 2023 will be a relatively normal year for consumers. Of course, the one wild card, which I believe has a low probability of occurring, is that a new variant causes a surprising massive spike in deaths.

The Top 10 List for 2021

January 20, 2021January 20, 2021 Mike Kwatinetz covid-19, Ecommerce, Economics, Golden State Warriors, Predictions, Startups, Stocks, Technology

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:

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:

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.
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.
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.
The product has been rated best in class numerous times
Its compression technology (the key ingredient in making video high quality) appears to have a multi-year lead over the competition
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:

The flight to larger outside space has caved urban pricing while driving up suburban values
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:

Immediate accessibility to what you want (unlike out of stock issues in Brick and Mortar retail)
Fast and Free shipping in most cases
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.

Recap of 2020 Top Ten Predictions

January 6, 2021 Mike Kwatinetz covid-19, Golden State Warriors, Predictions, Stocks, Technology, Unicorns Amazon, DocuSign, Facebook, Predictions, Stitch Fix, Stocks, Tesla, Zoom

Tesla’s new pickup truck due out late 2021

Bull Markets have Tended to Favor My Stock Picks

This may seem like a repeat of what you have heard from me in the past, but I enter each year with some trepidation as my favored stocks are high beta and usually had increased in value the prior year (in 2019 they were up about 46% or nearly double the S&P which also had a strong year). The fact is: I’m typically nervous that somehow my “luck” will run out. But, in 2020 I was actually pretty confident that my stock picks would perform well and would beat the market. I felt this confidence because the companies I liked were poised for another very strong growth year, had appreciated well under their growth over the prior 2-year period and were dominant players in each of their sub-sectors. Of course, no one could foresee the crazy year we would all face in 2020 as the worldwide pandemic radically changed society’s activities, purchasing behavior, and means of communication. As it turns out, of the 6 stocks I included in my top ten list 3 were beneficiaries of the pandemic, 2 were hurt by it and one was close to neutral. The pandemic beneficiaries experienced above normal revenue growth and each of the others faired reasonably well despite Covid’s impact. The market, after a major decline in March closed the year with double digit gains. Having said all that, I may never replicate my outperformance in 2020 as the 6 stocks had an average gain of an astounding 259% and every one of them outperformed the S&P gain of 14.6% quite handily.

Before reviewing each of my top ten from last year, I would like to once again reveal long term performance of the stock pick portion of the top ten list. I assume equal weighting for each stock in each year to come up with performance and then compound the yearly gains (or losses) to provide the 7-year performance. I’m comparing the S&P index at December 31 of each year to determine annual performance. Soundbyte’s compound gain for the 7-year period is 2049% which equates to an IRR of 55.0%. The S&P was up 106.1% during the same 7-year period, an IRR of 10.9%.

2020 Non-Stock Top Ten Predictions also Impacted by Covid

The pandemic not only affected stock performance, it had serious impact on my non-stock predictions. In the extreme, my prediction regarding the Warriors 2020-2021 season essentially became moot as the season was postponed to start in late December…so had barely over a week of games in the current year! My other 3 predictions were all affected as well. I’ll discuss each after reviewing the stock picks.

The 2020 Stocks Picked to Outperform the Market (S&P 500)

Tesla Stock which closed 2019 at $418/share and split 5 for 1 subsequently
Facebook which closed 2019 at $205/share
DocuSign which closed 2019 at $74/share
Stitch Fix which closed 2019 at $25.66/share
Amazon which closed 2019 at $1848/share
Zoom Video Communications which closed 2019 at $72.20/share

In last year’s recap I noted 3 of my picks had “amazing performance” as they were up between 51% and 72%. That is indeed amazing in any year. However, 2020 was not “any year”. The 6 picks made 2019 gains look like chopped liver as 4 of my 6 picks were up well over 100%, a 5^th was up over 70% and the last had gains of double the S&P. In the discussion below, I’ve listed in bold each of my ten predictions and give an evaluation of how I fared on each.

1. Tesla stock appreciation will continue to outperform the market (it closed last year at $418/share). Note that after the 5 for 1 split this adjusts to $84.50/share.

In 2020, Tesla provided one of the wildest rides I’ve ever seen. By all appearances, it was negatively impacted by the pandemic for three reasons: people reduced the amount they drove thereby lessening demand for buying a new vehicle, supply chains were disrupted, and Tesla’s Fremont plant was forced to be closed for seven weeks thereby limiting supply. Yet the company continued to establish itself as the dominant player in electronic, self-driving vehicles. It may have increased its lead in user software in its cars and it continued to maintain substantial advantages in battery technology. The environment was also quite favorable for a market share increase of eco-friendly vehicles.

Additionally, several other factors helped create demand for the stock. The 5 for 1 stock split, announced in August was clearly a factor in a 75% gain over a 3-week period. Inclusion in the S&P 500 helped cause an additional spike in the latter part of the year. Tesla expanded its product line into 2 new categories by launching the Model Y, a compact SUV, to rave reviews and demonstrating its planned pickup truck (due in late 2021) as well. While the truck demo had some snags, orders for it (with a small deposit) are currently over 650,000 units.

All in all, these factors led to Tesla closing the year at $706/share, post-split, an astounding gain of 744% making this the largest one year gain I’ve had in the 7 years of Soundbytes.

2. Facebook Stock will outpace the market (it closed 2019 at $205 per share)

Facebook was one of the companies that was hurt by the pandemic as major categories of advertising essentially disappeared for months. Among these were live events of any kind and associated ticketing company advertising, airlines and cruise lines, off-line retail, hotels, and much more. Combine this with the company’s continued issues with regulatory bodies, its stock faced an uphill battle in 2020. What enabled it to close the year at $273 per share, up 33% (over 2x the S&P), is that its valuation remains low by straight financial metrics.

3. DocuSign stock appreciation will continue to outperform the market (it closed 2019 at $74/share)

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. Since growth typically declines for high-growth companies this was significant. Investors also seemed to agree with me that the company would not lose the gains when the pandemic ends. Further, DocuSign expanded its product range into contract life-cycle management and several other categories thereby growing its TAM (total available market). Despite increased usage, DocuSign COGs did not rise (Gross Margin was 79% in Q3). 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.

4. Stitch Fix stock appreciation will continue to outperform the market (it closed 2019 at $25.66/share)

Stitch Fix had a roller coaster year mostly due to the pandemic driving people to work from home, which led to a decline in purchasing of clothes. I’m guessing many of you, like me, wear jeans and a fleece or sweatshirt most days so our need for new clothes is reduced. This caused Stitch Fix to have negative growth earlier in the year and for its stock to drop in price over 50% by early April. But, the other side of the equation is that brick and mortar stores lost meaningful share to eMerchants like Stitch Fix. So, in the October quarter, Stitch Fix returned to growth after 2 weak quarters caused by the pandemic. The growth of revenue at 10% YoY was below their pre-pandemic level but represented a dramatic turn in its fortunes. Additionally, the CEO guided to 20-25% growth going forward. The stock reacted very positively and closed the year at $58.72/share up 129% for the year.

5. Amazon stock strategy will outpace the market (it closed last year at $1848/share)

Amazon had a banner year in 2020 with a jump in growth driven by the pandemic. Net sales grew 37% YoY in Q3 as compared to an approximate 20% level, pre-pandemic. Their gains were in every category and every geography but certainly eCommerce led the way as consumers shifted more of their buying to the web. Of course, such a shift also meant increased growth for AWS as well. Net Income in Q3 was up 197% YoY to over $6.3 billion. Given the increase in its growth rate and strong earnings the stock performed quite well in 2020 and was up 76% to $3257/share.

In our post we also recommended selling puts with a strike price of $1750 as an augmented strategy to boost returns. Had someone done that the return would have increased to 89%. For the purposes of blog performance, I will continue to use the stock price increase for performance. Regardless, this pick was another winner.

6. I added Zoom Media to the list of recommended stocks. It closed 2019 at $72.20

When I put Zoom on my list of recommended stocks, I had no idea we’d be going through a pandemic that would turn it into a household name. Instead, I was confident that the migration from audio calls to video conference calls would continue to accelerate and Zoom has the best product and pricing in the category. For its fiscal 2020-year (ending in January, 2020) Zoom grew revenue 78% with the final sequential quarter of the year growth at 13.0%. Once the pandemic hit, Zoom sales accelerated greatly with the April quarter up 74% sequentially and 169% YoY. The April quarter only had 5 weeks of pandemic benefit. The July quarter had a full 3 months of benefit and increased an astounding 102% sequentially and 355% YoY. Q3, the October quarter continued the upward trend but now had a full quarter of the pandemic as a sequential compare. So, while the YoY growth was 367%, the sequential quarterly growth began to normalize. At over 17% it still exceeded what it was averaging for the quarters preceding the pandemic but was a disappointment to investors and the stock has been trading off since reporting Q3 numbers. Regardless of the pullback, the stock is ahead 369% in 2020, closing the year at $337/share .

In the post we also outlined a strategy that combined selling both put and call options with purchasing the stock. Later in the year we pointed out that buying back the calls and selling the stock made sense mid-year if one wanted to maximize IRR. If one had followed the strategy (including the buyback we suggested) the return would still have been well over a 100% IRR but clearly lower than the return without the options. As with Amazon, for blog performance, we are only focused on the straight stock strategy. And this recommendation turned out to be stellar.

Unusual Year for the Non-Stock Predictions

7. The major election year will cause a substantial increase in advertising dollars spent

This forecast proved quite valid. Michael Bloomberg alone spent over $1 billion during his primary run. The Center for Responsive Politics reported that they projected just under $11 billion in spending would take place between candidates for president, the Senate and the House in the general election. This was about 50% higher than in 2016. Additionally, there will be incremental dollars devoted to the runoff Senate races in Georgia. This increase helped advertising companies offset some of the lost revenue discussed above.

8. Automation of Retail will continue to gain momentum

Given the pandemic, most projects were suspended so this did not take place. And it may be a while before we have enough normalization for this trend to resume, but I am confident it will. However, the pandemic also caused an acceleration in eCommerce for brick and mortar supermarkets and restaurants. I’m guessing almost everyone reading this post has increased their use of one or more of: Instacart, Amazon Fresh, Walmart delivery, Safeway delivery, Uber Eats, GrubHub, Doordash, etc. My wife and I even started ordering specialty foods (like lox) from New York through either Goldbelly or Zabars. Restaurants that would not have dreamed of focusing on takeout through eCommerce are now immersed in it. While this was not the automation that I had contemplated it still represents a radical change.

9. The Warriors will come back strong in the 2020/2021 season

This was my fun prediction. Unfortunately, the combination of injuries and Covid eliminated fun for sports fans. I expected that there would be enough games in 2020 to evaluate whether my forecast was correct or not. Since the season started in late December its premature to evaluate it. Also, I pointed out that the team had to stay relatively healthy for the prediction to work. Guess what? The Warriors have already had 2 devastating injuries (Thompson the critical one, and Chriss, who I expected would help the second team as well).

Yet, several things I predicted in the post have occurred:

The younger players did develop last season, especially Pascal
The Warriors did get a very high draft choice and at first blush he seems like a winner
The Warriors did use the Iguodala cap space to sign a strong veteran, Oubre.

Given the absence of Thompson, the team will be successful if they make the playoffs. So, let’s suspend evaluating the forecast to see if that occurs in a packed Western Conference despite losing Thompson. Last year they started 4 and 16. For the 2020-2021 season (as of January 3) they are 3 and 3 and appear to be a much better team that needs time to jell. But the jury is out as to how good (or bad) they will be.

10. At least one of the major Unicorns will be acquired by a larger player

There were 9 Unicorns listed in the post. Eight are still going at it by themselves but the 9^th, Slack, has recently been acquired by SalesForce making this an accurate prediction.

2021 Predictions coming soon

Stay tuned for my top ten predictions for 2021… but please note most of the 6 stocks from 2020 will continue on the list and as usual, for these stocks, we will use their 2020 closing prices as the start price for 2021. For any new stock we add, we will use the price of the stock as we are writing the post.

Soundbytes

I thought I would share something I saw elsewhere regarding New Year’s wishes. In the past most people wished for things like success for themselves and/or family members in one form or another. The pandemic has even transformed this. Today, I believe most people are more focused on wishing for health for them, their family, friends, and an end to this terrible pandemic. Please take care of yourselves, stay safe. We are getting closer to the end as vaccines are here and will get rolled out to all of us over the next 4-6 months.

2020 Top Ten Predictions

January 10, 2020 Mike Kwatinetz Ecommerce, Economics, Golden State Warriors, Marketing, Metrics, NBA, Predictions, Startups, Stocks, Technology, Unicorns 2020, Amazon, DocuSign, Facebook, Golden State Warriors, Predictions, Stitch Fix, Tesla, Zoom

I wanted to start this post by repeating something I discussed in my top ten lists in 2017 and 2018 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).

Let’s do a little simple math. Suppose one can generate an IRR of 26% per year (my target is to be over 25%) over a long period of time. The wonder of compounding is that at 26% per year your assets will double every 3 years. In 6 years, this would mean 4X your original investment dollars and in 12 years the result would be 16X. For comparison purposes, at 5% per year your assets would only be 1.8X in 12 years and at 10% IRR 3.1X. While 25%+ IRR represents very high performance, I have been fortunate enough to consistently exceed it (but always am worried that it can’t keep up)! For my recommendations of the past 6 years, the IRR is 34.8% and since this exceeds 26%, the 6-year performance is roughly 6X rather than 4X.

What is the trick to achieving 25% plus IRR? Here are a few of my basic rules:

Start with companies growing revenue 20% or more, where those closer to 20% also have opportunity to expand income faster than revenue
Make sure the market they are attacking is large enough to support continued high growth for at least 5 years forward
Stay away from companies that don’t have profitability in sight as companies eventually should trade at a multiple of earnings.
Only choose companies with competitive advantages in their space
Re-evaluate your choices periodically but don’t be consumed by short term movement

As I go through each of my 6 stock picks I have also considered where the stock currently trades relative to its growth and other performance metrics. With that in mind, as is my tendency (and was stated in my last post), I am continuing to recommend Tesla, Facebook, Amazon, Stitch Fix and DocuSign. I am adding Zoom Video Communications (ZM) to the list. For Zoom and Amazon I will recommend a more complex transaction to achieve my target return.

2020 Stock Recommendations:

1. Tesla stock appreciation will continue to outperform the market (it closed last year at $418/share)

Tesla is likely to continue to be a 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 2020 because:

The model 3 continues to be one of the most attractive cars on the market. Electric Car Reviews has come out with a report stating that Model 3 cost of ownership not only blows away the Audi AS but is also lower than a Toyota Camry! The analysis is that the 5-year cost of ownership of the Tesla is $0.46 per mile while the Audi AS comes in 70% higher at $0.80 per mile. While Audi being more expensive is no surprise, what is shocking is how much more expensive it is. The report also determined that Toyota Camry has a higher cost as well ($0.49/mile)! Given the fact that the Tesla is a luxury vehicle and the Camry is far from that, why would anyone with this knowledge decide to buy a low-end car like a Camry over a Model 3 when the Camry costs more to own? What gets the Tesla to a lower cost than the Camry is much lower fuel cost, virtually no maintenance cost and high resale value. While the Camry purchase price is lower, these factors more than make up for the initial price difference
China, the largest market for electronic vehicles, is about to take off in sales. With the new production facility in China going live, Tesla will be able to significantly increase production in 2020 and will benefit from the car no longer being subject to import duties in China.
European demand for Teslas is increasing dramatically. With its Chinese plant going live, Tesla will be able to partly meet European demand which could be as high as the U.S. in the future. The company is building another factory in Europe in anticipation. The earliest indicator of just how much market share Tesla can reach has occurred in Norway where electric cars receive numerous incentives. Tesla is now the best selling car in that country and demand for electric cars there now exceeds gas driven vehicles.

While 2020 is shaping up as a stairstep uptick in sales for Tesla given increased capacity and demand, various factors augur continued growth well beyond 2020. For example, Tesla is only partway towards having a full lineup of vehicles. In the future it will add:

Pickup trucks – where pre-orders and recent surveys indicate it will acquire 10-20% of that market
A lower priced SUV – at Model 3 type pricing this will be attacking a much larger market than the Model X
A sports car – early specifications indicate that it could rival Ferrari in performance but at pricing more like a Porsche
A refreshed version of the Model S
A semi – where the lower cost of fuel and maintenance could mean strong market share.

2. Facebook stock appreciation will continue to outperform the market (it closed last year at $205/share)

Facebook, like Tesla, continues to have a great deal of controversy surrounding it and therefore may sometimes have price drops that its financial metrics do not warrant. This was the case in 2018 when the stock dropped 28% in value during that year. While 2019 partly recovered from what I believe was an excessive reaction, it’s important to note that the 2019 year-end price of $205/share was only 16% higher than at the end of 2017 while trailing revenue will have grown by about 75% in the 2-year period. The EPS run rate should be up in a similar way after a few quarters of lower earnings in early 2019. My point is that the stock remains at a low price given its metrics. I expect Q4 to be quite strong and believe 2020 will continue to show solid growth.

The Facebook platform is still increasing the number of active users, albeit by only about 5%-6%. Additionally, Facebook continues to increase inventory utilization and pricing. In fact, given what I anticipate will be added advertising spend due to the heated elections for president, senate seats, governorships etc., Facebook advertising inventory usage and rates could increase faster (see prediction 7 on election spending).

Facebook should also benefit by an acceleration of commerce and increased monetization of advertising on Instagram. Facebook started monetizing that platform in 2017 and Instagram revenue has been growing exponentially and is likely to close out 2019 at well over $10 billion. A wild card for growth is potential monetization of WhatsApp. That platform now has over 1.5 billion active users with over 300 million active every day. It appears close to beginning monetization.

The factors discussed could enable Facebook to continue to grow revenue at 20% – 30% annually for another 3-5 years making it a sound longer term investment.

3. DocuSign stock appreciation will continue to outperform the market (it closed last year at $74/share)

The company is a SaaS company with a stable revenue base of over 560,000 customers at the end of October, up well over 20% from a year earlier. Its strategy is one of land and expand with revenue from existing customers increasing each year leading to a roughly 40% year over year revenue increase in the most recent quarter (fiscal Q3). SaaS products account for over 95% of revenue with professional services providing the rest. As a SaaS company, gross margins are high at 79% (on a non-GAAP basis).

The company has now reached positive earnings on a non-GAAP basis of $0.11/share versus $0.00 a year ago. I use non-GAAP as GAAP financials distort actual results by creating extra cost on the P&L if the company’s stock appreciates. These costs are theoretic rather than real.

My only concern with this recommendation is that the stock has had a 72% runup in 2019 but given its growth, move to positive earnings and the fact that SaaS companies trade at higher multiples of revenue than others I still believe it can outperform this year.

4. Stitch Fix Stock appreciation will continue to outperform the market (it closed last year at $25.66/share)

Stitch Fix offers customers, who are primarily women, the ability to shop from home by sending them a box with several items selected based on sophisticated analysis of her 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 approaching a $2 billion run rate. Unlike many of the recent IPO companies, it has shown an ability to balance growth and earnings. The stock had a strong 2019 ending the year at $25.66 per share up 51% over the 2018 closing price. Despite this, our valuation methodology continues to show it to be substantially under valued and it remains one of my picks for 2020. The likely cause of what I believe is a low valuation is a fear of Amazon making it difficult for Stitch Fix to succeed. As the company gets larger this fear should recede helping the multiple to expand.

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. Therefore, the company can spend less on acquiring new customers as it has increased its ability to get existing customers to spend more and come back more often. Stitch Fix can continue to grow its revenue from women in the U.S. with expansion opportunities in international markets over time. I believe the company can continue to grow by roughly 20% or more in 2020 and beyond.

Stitch Fix revenue growth (of over 21% in the latest reported quarter) comes from a combination of increasing the number of active clients by 17% to 3.4 million, coupled with driving higher revenue per active client. The company accomplished this while generating profits on a non-GAAP basis.

5. Amazon stock strategy will outpace the market (it closed last year at $1848/share).

Amazon shares increased by 23% last year while revenue in Q3 was up 24% year over year. This meant the stock performance mirrored revenue growth. Growth in the core commerce business has slowed but Amazon’s cloud and echo/Alexa businesses are strong enough to help the company maintain roughly 20% growth in 2020. The company continues to invest heavily in R&D with a push to create automated retail stores one of its latest initiatives. If that proves successful, Amazon can greatly expand its physical presence and potentially increase growth through the rollout of numerous brick and mortar locations. But at its current size, it will be difficult for the company to maintain over 20% revenue growth for many years (excluding acquisitions) so I am suggesting a more complex investment in this stock:

Buy X shares of the stock (or keep the ones you have)
Sell Amazon puts for the same number of shares with the puts expiring on January 15, 2021 and having a strike price of $1750. The most recent sale of these puts was for over $126
So, net out of pocket cost would be reduced to $1722
A 20% increase in the stock price (roughly Amazon’s growth rate) would mean 29% growth in value since the puts would expire worthless
If the stock declined 226 points the option sale would be a break-even. Any decline beyond that and you would lose additional dollars.
If the options still have a premium on December 31, I will measure their value on January 15, 2021 for the purposes of performance.

6. I’m adding Zoom Video Communications to the list but with an even more complex investment strategy (the stock is currently at $72.20)

I discussed Zoom Video Communications (ZM) in my post on June 24, 2019. In that post I described the reasons I liked Zoom for the long term:

Revenue retention of a cohort was about 140%
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
Gross Margins are over 80% and could increase
The product has been rated best in class numerous times
Its compression technology (the key ingredient in making video high quality) appears to have a multi-year lead over the competition
Adding to those reasons it’s important to note that ZM is improving earnings and was slightly profitable in its most recent reported quarter

The fly in the ointment was that my valuation technology showed that it was overvalued. However, I came up with a way of “future pricing” the stock. Since I expected revenue to grow by about 150% over the next 7 quarters (at the time it was growing over 100% year over year) “future pricing” would make it an attractive stock. This was possible due to the extremely high premiums for options in the stock. So far that call is working out. Despite the company growing revenue in the 3 quarters subsequent to my post by over 57%, my concern about valuation has proven correct and the stock has declined from $76.92 to $72.20. If I closed out the position today by selling the stock and buying back the options (see Table 1) my return for less than 7.5 months would be a 42% profit. This has occurred despite the stock declining slightly due to shrinkage in the premiums.

Table 1: Previous Zoom trade and proposed trade

I typically prefer using longer term options for doing this type of trade as revenue growth of this magnitude should eventually cause the stock to rise, plus the premiums on options that are further out are much higher, reducing the risk profile, but I will construct this trade so that the options expire on January 15, 2021 to be able to evaluate it in one year. In measuring my performance we’ll use the closing stock price on the option expiration date, January 15, 2021 since premiums in options persist until their expiration date so the extra 2 weeks leads to better optimization of the trade.

So, here is the proposed trade (see table 1):

Buy X shares of the stock at $72.20 (today’s price)
Sell Calls for X shares expiring January 15, 2021 at a strike of $80/share for $11.50 (same as last price it traded)
Sell puts for X shares expiring January 15, 2021 with strike of $65/share for $10.00 (same as last price it traded)

I expect revenue growth of 60% or more 4 quarters out. I also expect the stock to rise some portion of that, as it is now closer to its value than when I did the earlier transaction on May 31, 2019. Check my prior post for further analysis on Zoom, but here are 3 cases that matter at December 31, 2020:

Stock closes over $80/share (up 11% or more) at end of the year: the profit would be 58% of the net cost of the transaction
- This would happen because the stock would be called, and you would get $80/share
- The put would expire worthless
- Since you paid a net cost of $50.70, net profit would be $29.30
Stock closes flat at $72.20: your profit would be $21.50 (42%)
- The put and the call would each expire worthless, so you would earn the original premiums you received when you sold them
- The stock would be worth the same as what you paid
Stock closes at $57.85 on December 31: you would be at break even. If it closed lower, then losses would accumulate twice as quickly:
- The put holder would require you to buy the stock at the put exercise price of $65, $7.15 more than it would be worth
- The call would expire worthless
- The original stock would have declined from $72.20 to $57.85, a loss of $14.35
- The loss on the stock and put together would equal $21.50, the original premiums you received for those options

Outside of my stock picks, I always like to make a few non-stock predictions for the year ahead.

7. The major election year will cause a substantial increase in advertising dollars spent

According to Advertising Analytics political spending has grown an average of 27% per year since 2012. Both the rise of Super PACs and the launch of online donation tools such as ActBlue have substantially contributed to this growth. While much of the spend is targeted at TV, online platforms have seen an increasing share of the dollars, especially Facebook and Google. The spend is primarily in even years, as those are the ones with senate, house and gubernatorial races (except for minor exceptions). Of course, every 4^th year this is boosted by the added spend from presidential candidates. The Wall Street Journal projects the 2020 amount will be about $9.9 billion…up nearly 60% from the 2016 election year. It should be noted that the forecast was prior to Bloomberg entering the race and if he remains a viable candidate an additional $2 billion or more could be added to this total.

The portion targeted at the digital world is projected to be about $2.8 billion or about 2.2% of total digital ad spending. Much of these dollars will likely go to Facebook and Google. This spend has a dual impact: first it adds to the revenue of each platform in a direct way, but secondly it can also cause the cost of advertising on those platforms to rise for others as well.

8. Automation of Retail will continue to gain momentum

This will happen in multiple ways, including:

More Brick & Mortar locations will offer some or all the SKUs in the store for online purchase through Kiosks (assisted by clerks/sales personnel). By doing this, merchants will be able to offer a larger variety of items, styles, sizes and colors than can be carried in any one outlet. In addition, the consolidation of inventory achieved in this manner will add efficiency to the business model. In the case of clothing, such stores will carry samples of items so the customer can try them on, partly to optimize fit but also to determine whether he or she likes the way it looks and feels on them. If one observes the massive use of Kiosks at airports it becomes obvious that they reduce the number of employees needed and can speed up checking in. One conclusion is this will be the wave of the future for multiple consumer-based industries.
Many more locations will begin incorporating technology to eliminate the number of employees needed in their stores. Amazon will likely be a leader in this, but others will also provide ways to reduce the cost of ordering, picking goods, checking out and receiving information while at the store.

9. The Warriors will come back strong in the 2020/21 season

Let me begin by saying that this prediction is not being made because I have been so humbled by my miss in the July post where I predicted that the Warriors could edge into the 2020 playoffs and then contend for a title if Klay returned in late February/early March. Rather, it is based on analysis of their opportunity for next season and also an attempt to add a little fun to my Top Ten List! The benefit of this season:

Klay and Curry are getting substantial time off after 5 seasons of heavy stress. They should be refreshed at the start of next season
Russell, assuming he doesn’t keep missing games with injuries, is learning the Warriors style of play
Because of the injuries to Klay, Curry, Looney, and to a lesser extent Green and Russell, several of the younger members of the team are getting experience at a much more rapid rate than would normally be possible and the Warriors are able to have more time to evaluate them as potential long-term assets
If the Warriors continue to lose at their current rate, they will be able to get a high draft choice for the first time since 2012 when they drafted Harrison Barnes with the 7^th pick. Since then their highest pick has been between the 28^th and 30^th player chosen (30 is the lowest pick in the first round)
The Warriors will have more cap space available to sign a quality veteran
Andre Iguodala might re-sign with the team, and while this is not necessary for my prediction it would be great for him and for the team
The veterans should be hungry again after several years of almost being bored during the regular season

I am assuming the Warriors will be relatively healthy next season for this to occur.

10. At least one of the major Unicorns will be acquired by a larger player

In 2019, there was a change to the investing environment where most companies that did not show a hint of potential profitability had difficulty maintaining their market price. This was particularly true of highly touted Unicorns, which mostly struggled to increase their share price dramatically from the price each closed on the day of their IPO. Table 2 shows the 9 Unicorns whose IPOs we highlighted in our last post. Other than Beyond Meat, Zoom and Pinterest, they all appear some distance from turning a proforma profit. Five of the other six are below their price on the first day’s close. A 6^th, Peloton, is slightly above the IPO price (and further above the first days close). Beyond Meat grew revenue 250% in its latest quarter and moved to profitability as well. Its stock jumped on the first day and is even higher today. While Pinterest is showing an ability to be profitable it is still between the price of the IPO and its close on the first day of trading. Zoom, which is one of our recommended buys, was profitable (on a Non-GAAP basis) and grew revenue 85% in its most recent quarter. A 10^th player, WeWork, had such substantial losses that it was unable to have a successful IPO.

Table 2: Recent Unicorn IPOs Stock Price & Profitability Comparisons

Something that each of these companies have in common is that they are all growing revenue at 30% or more, are attacking large markets, and are either in the leadership position in that market or are one of two in such a position. Because of this I believe one or more of these (and comparable Unicorns) could be an interesting acquisition for a much larger company who is willing to help make them profitable. For such an acquirer their growth and leadership position could be quite attractive.

Why Apple Acquiring Tesla Seems an Obvious Step…

August 20, 2019August 22, 2019 Mike Kwatinetz Golden State Warriors, Predictions, Startups, Technology Apple, Tesla, Zoom

…and why the obvious probably won’t happen!

A Look at Apple history

Apple’s progress from a company in trouble to becoming the first company to reach a trillion dollar market cap meant over 400X appreciation in Apple stock. The metamorphosis began when the company hired Fred Anderson as an Executive VP and CFO in 1996. Tim Cook joined the company as senior VP of worldwide operations in 1998. Fred and Tim improved the company operationally, eliminating wasteful spending that preceded their tenure. Of course, as most of you undoubtedly know, bringing back Steve Jobs by acquiring his company, NeXT Computer in early 1997 added a strategic genius and great marketer to an Apple that now had an improved business model. Virtually every successful current Apple product was conceived while Steve was there. After Fred retired in 2004, Tim Cook assumed even more of a leadership role than before and eventually became CEO shortly before Jobs’ death in 2011.

Apple post Steve Jobs

Tim Cook is a great operator. In the years following the death of Steve Jobs he squeezed every bit of profit that is possible out of the iPad, iPod, iMacs, music content, app store sales and most of all the iPhone. Because great products have a long life cycle they can increase in sales for many years before flattening out and then declining.

Table 1: Illustrative Sales Lifecycle for Great Tech Product

Cook’s limit is that he cannot conceptualize new products in the way Steve Jobs did. After all, who, besides an Elon Musk, could? The problem for Apple is that if it is to return to double digit growth, it needs a really large, successful new product as the iPhone is flattening in sales and the Apple Watch and other new initiatives have not sufficiently moved the needle to offset it. Assuming Q4 revenue growth in FY 2019 is consistent with the first 9 months, then Apple’s compound growth over the 4 years from FY 15 to FY 19 will be 3.0% (see Table 2) including the benefit of acquisitions like Beats.

iPhone sales have flattened

The problem for Apple is that the iPhone is now in the mature part of its sales life cycle. In fact, unit sales appear to be declining (Graph 1) but Apple’s near monopoly pricing power has allowed it to defy the typical price cycle for technology products where average selling prices decline over time. The iPhone has gone from a price range of $99 to $299 in June 2009 to $999 to $1449 for the iPhoneX, while the older iPhone 7 is still available with minimal storage for $449. That’s a 4.5X price increase at the bottom and nearly 5X at the high end! This defies gravity for technology products.

Graph 1: iPhone Unit Sales (2007-2018)

In the many years I followed the PC market, it kept growing until reaching the following set of conditions (which the iPhone now also faces):

Improvements in features were no longer enough to drive rapid replacement cycles
Pricing was under pressure as component costs declined and it became more difficult to convince buyers to add capacity or capability sufficient to hold prices where they were
The number of first time users available to buy product was no longer increasing each year
Competition from lower priced suppliers created pricing pressure

Prior to that time PC pricing could be maintained by convincing buyers that they needed one or more of:

The next generation of processor
A larger or thinner screen
Next generation storage technology

What is interesting when we contrast this with iPhones is that PC manufacturers struggled to maintain average selling prices (ASPs) until they finally began declining in the early 2000s. Similarly, products like DVD players, VCRs, LCD TVs and almost every other technology driven product had to drop dramatically in price to attract a mass market. In contrast to that, Apple has been able to increase average prices at the same time that the iPhone became a mass market product. This helped Apple postpone the inevitable revenue flattening and subsequent decline due to lengthening replacement cycles and fewer first time buyers. In the past few years, other then the bump in FY 2018 from the launch of the high priced Model X early that fiscal year, iPhone revenue has essentially been flat to down. Since it is well over 50% of Apple revenue, this puts great pressure on overall revenue growth.

To get back to double digit growth Apple needs to enter a really large market

To be clear, Apple is likely to continue to be a successful, highly profitable company for many years even if it does not make any dramatic acquisitions. While its growth may be slow, its after tax profits has been above 20% for each of the past 5 years. Strong cash flow has enabled the company to buy back stock and to support increasing dividends every year since August 2014.

Despite this, I think Apple would be well served by using a portion of their cash to make an acquisition that enables them to enter a very large market with a product that already has a great brand, traction, and superior technology. This could protect them if the iPhone enters the downside of its revenue generating cycle (and it is starting to feel that will happen sometime in the next few years). Further, Apple would benefit if the company they acquired had a visionary leader who could be the new “Steve Jobs” for Apple.

There is no better opportunity than autos

If Apple laid out criteria for what sector to target, they might want to:

Find a sector that is at least hundreds of billions of dollars in size
Find a sector in the midst of major transition
Find a sector where market share is widely spread
Find a sector ripe for disruption where the vast majority of participants are “old school”

The Automobile industry matches every criterion:

Matching 1. It is well over $3 trillion in size

Matching 2. Cars are transitioning to electric from gas and are becoming the next technology platform

Matching 3. Eight players have between 5% and 11% market share and 7 more between 2% and 5%

Matching 4. The top ten manufacturers all started well over 50 years ago

And no better fit for Apple than Tesla

Tesla reminds me of Apple in the late 1990s. Its advocates are passionate about the company and its products. It can charge a premium versus others because it has the best battery technology coupled with the smartest software technology. The company also designs its cars from the ground up, rather than retrofitting older models, focusing on what the modern buyer would most want. Like Jobs was at Apple, Musk cares about every detail of the product and insists on ease of use wherever possible. The business model includes owning distribution outlets much like Apple Stores have done for Apple. By owning the outlets, Tesla can control its brand image much better than any other auto manufacturer. While there has been much chatter about Google and Uber in terms of self-driving cars, Tesla is the furthest along at putting product into the market to test this technology.

Tesla may have many advantages over others, but it takes time to build up market share and the company is still around 0.5% of the market (in units). It takes several years to bring a new model to market and Tesla has yet to enter several categories. It also takes time and considerable capital to build out efficient manufacturing capability and Tesla has struggled to keep up with demand. But, the two directions that the market is moving towards are all electric cars and smart, autonomous vehicles. Tesla appears to have a multi-year lead in both. What this means is that with enough capital and strong operational direction Tesla seems poised to gain significant market share.

Apple could accelerate Tesla’s growth

If Apple acquired Tesla it could:

Supply capital to accelerate launch of new models
Supply capital for more factories
Increase distribution by offering Tesla products in Apple Stores (this would be done virtually using large computer screens). An extra benefit from this would be adding buzz to Apple stores
Supply operational knowhow that would increase Tesla efficiency
Add to the luster of the Tesla brand by it being part of Apple
Integrate improved entertainment product (and add subscriptions) into Tesla cars

These steps would likely drive continued high growth for Tesla. If, with this type of support, it could get to 5% share in 3-5 years that would put it around $200 billion in revenue which would be higher than the iPhone is currently. Additionally, Elon Musk is possibly the greatest innovator since Steve Jobs. As a result, Tesla would bring to Apple the best battery technology, the strongest power storage technology, and the leading solar energy company. More importantly, Apple would also gain a great innovator.

The Cost of such an acquisition is well within Apple’s means

At the end of fiscal Q3, Apple had about $95 billion in cash and equivalents plus another $116 billion in marketable securities. It also has averaged over $50 billion in after tax profits annually for the past 5 fiscal years (including the current one). Tesla market cap is about $40 billion. I’m guessing Apple could potentially acquire it for less than $60 billion (which would be a large premium over where it is trading). This would be easy for Apple to afford and would create zero dilution for Apple stockholders.

If the Fit is so strong and the means are there, why won’t it happen?

I can sum up the answer in one word – ego. I’m not sure Tim Cook is willing to admit that Elon would be a far better strategist for Apple than him. I’m not sure he would be willing to give Elon the role of guiding Apple on the product side. I’m not sure Elon Musk is willing to admit he is not the operator that Tim Cook is (remember Steve Jobs had to find out he needed the right operating/financial partners by getting fired by Apple and essentially failing at NeXT). I’m not sure Elon is willing to give up being the CEO and controlling decision-maker for his companies.

So, this probably will never happen but if it did, I believe it would be the greatest business powerhouse in history!

Soundbytes

USA Today just published a story that agreed with our last Soundbytes analysis of why Klay Thompson is underrated.
I expect Zoom Video to beat revenue estimates of $129 million to $130 million for the July Quarter by about $5 million or more

The Warriors Ain’t Dead Yet!

July 23, 2019July 31, 2019 Mike Kwatinetz Golden State Warriors, NBA, Sports, Thoughts basketball, Golden State Warriors, Klay Thompson, NBA, Sports, Stephen Curry

Why the team is still a contender

My long term readers know that every so often the blog wanders into the sports arena. In doing so, I apply the same type of analysis that I do for public stocks and for VC investments to sports, and usually, basketball. Given all the turmoil that has occurred in the NBA this off-season, including the Warriors losing Durant, Iguodala, Livingston, Cousins and several other players, I thought it would be interesting to evaluate the newly changed team. Both ESPN and CBS power rankings have them 7^th in the West and 11^th in the NBA. I find that an overreaction as the Warriors may have beaten the Raptors if Klay Thompson not been injured, they swept Portland, and won the last 2 Rockets games without Durant. At the time this drove a lot of chatter that the team might be better off without Durant (I disagree).

But rather then compare the revised roster to last year’s, it seems more closely matched with the 2014-15 team, as that was a championship team that did not include Kevin Durant. I will make 2 key assumptions:

Klay Thompson will return by the end of February and be as effective as he was before his injury
The Warriors will make the playoffs despite missing Thompson for the majority of the season

It all starts with Curry

A third key assumption that has been proven over and over again is that players that come to the Warriors usually perform better as they benefit from the “Curry Effect”, namely, getting more shots without having someone closely guarding them, (The Curry Effect), resulting in an average improved shooting percentage of over 5%. In all fairness, it really is the “Curry plus Thompson Effect” as the extreme focus on preventing the two of them from taking 3 point shots is what frees up others. It helps that Curry is unselfish and readily passes the ball when he is double or triple teamed. Thompson’s passing has improved substantially but since he gets his shot off so quickly, he has less need to pass it. Last year both shot over 40% from 3 despite defensive efforts focused on preventing each of them from taking those shots.

Starting Teams: 2019-20 vs 2014-15

Table 1

Curry, Thompson and Green, the heart and soul of the Warriors, all remain from the 2014-15 roster, and now are at their peaks. In the 2014-15 season when Green first became a starter, Curry was one year away from reaching his peak and Thompson was just coming into his own especially on defense. I believe each of them is better today then they were at that time. At his best, Bogut may have been better than Cauley-Stein, but by 2014 Bogut had been through a number of injuries. Last year Cauley-Stein averaged nearly double the points of 2014 Bogut (11.9 vs 6.3), took slightly more rebounds per game and was a better free throw shooter. Stein, much like Bogut, is also considered a solid pick setter and defender. Russell is someone who should benefit greatly from playing with Curry. Even without that, last season he averaged over twice as many points per game as 2014 Barnes (21.1 vs 10.1) which should take considerable pressure off Curry (and Klay when he returns). However, Barnes was a better defender in 2014 than Russell is today. I give the edge to all 5 starters on the 2019 starting team compared to the 5 that started in 2014-15.

Thompson may be the most underrated player in the league!

It’s unfortunate that Thompson was injured in game 6 of the 2019 finals as he was once again proving just how good he can be. Not only was he playing lockdown defense, but he also drove the offense in what has been referred to as a typical Klay game 6. In just 32 minutes, before getting injured, he scored 30 points on 83% effective shooting percentage (67% on 3s), went 10 for 10 on free throws, and had 5 rebounds and 2 steals. I believe Golden State, even without Durant, would have forced a game 7 if Thompson did not get injured.

It boggles my mind that one of the websites could refer to Thompson as “an average player” who did not merit a max contract. This is bordering on the ridiculous and has a lot to do with the fact that the most important measure of shooting, effective shooting percentage (where each 3 made counts as 1½ 2 point shots made) does not normally get reported (or even noticed). In Table 2, I list the top 31 scorers from last season (everyone who averaged at least 20 points per game) and rank them by effective shooting. Thompson is number 8 in effective shooting and number 3 in 3-point percentage among this group. So, if effective shooting percentage was regularly published, Thompson would show up consistently helping the perception of his value. When this is coupled with his being a third team all-defensive player (i.e., one of the top 15 defenders in the league) it appears clear that he should be considered one of the top 15 players in the league.

Table 2: Top Scorers 2018-2019 Season

6th Man 2019-20 vs 2014-15

Kevon Looney has emerged as a potential star in the works. While he may not yet be the defensive presence of Iguodala, he is getting close. His scoring per minute played was higher than Andre’s 2014-15 numbers and his rebounds per minute were more than twice as much. While Iguodala had greater presence and could run the team as well as assist others in scoring, Looney at least partly makes up for this in his ability to set screens. Looney also has a much higher effective shooting percentage (62.7% vs 54.0%) than Andre had in 2014-15. While Kevon doesn’t shoot 3s he gets many points by putting back offensive rebounds and dunking lob passes. Overall, I give the edge to Iguodala based on the Looney of last season but given Looney’s potential to improve this might be dead even in the coming one.

Rest of the Bench for the 2 teams

It is the bench that is hardest to evaluate. Unlike last year’s bench, the 2014-15 bench was quite strong which spawned the Warrior logo “Strength in Numbers”. It included quality veteran players like Leandro Barbosa, David Lee, Mareese Sprouts and Shaun Livingston, who was playing at a much higher level than last season. The four of these together averaged over 26 points per game. This coming year’s bench is much younger and more athletic. It includes Alec Burks, Glenn Robinson, Alfonzo McKinnie and Omari Spellman, plus several rookies and Jacob Evans III. The first four are all capable of scoring and are solid 3-point shooters (they could increase to well above average once with the Warriors). I expect that group, coupled with one or two of the others, to exceed the 2014-15 bench in defense…but may not have as much scoring fire power. The team is likely to give one or two of the rookies as well as Evans opportunities to earn minutes as well. The bench is an improvement over last year but may not be as strong as the 2014-15 squads.

Overall Assessment

I believe the 2019-2020 squad is better than the championship team of 2015. The starting lineup features the core 3 players who have improved since then, D’Angelo Russell who was an all-star last year, and a solid center in Willie Cauley-Stein making the edge substantial. Looney as 6^th man is already giving evidence of future stardom. While he was not quite the Andre Iguodala of 2014-15, the difference is modest, and Looney continues to improve. The 2014-15 bench appears superior to that of next season, but the edge is not great as the newer group should be stronger defensively and is not far off the older group as scorers – the question will be how well they gel and how much the Curry/Klay factor improves their scoring. Finally, I think Kerr is a better coach today than he was given the last 5 years of experience.

They May Have Improved vs 2014-15, but so has the Competition

ESPN and CBS power rankings reflect the fact that multiple teams have created new “super star” two-somes:

Lakers: Lebron and Anthony Davis
Clippers: Kawhi Leonard and Paul George
Houston: Harden and Westbrook (in place of Chris Paul)
Nets: Kyrie Irving and Durant

Contenders also include improving young teams like Boston, Philadelphia, Denver, and Utah plus an improved Portland squad. This makes the landscape much tougher than when the Warriors won their 2015 championship. Yet, none of these teams seem better than the Cleveland team (led by a younger LeBron, Kyrie Irving and Kevin Love) the Warriors beat in 2015. So, assuming Klay returns by late February and is back to par, I believe the Warriors will remain strong contenders given the starting team with four all-stars augmented by Willie Cauley-Stein and an improving Kevon Looney as 6^th man. However, it will be much tougher going in the early rounds in the playoffs, making getting to the finals longer odds than in each of the past 5 years.

SoundBytes

An examination of Table 2 reveals several interesting facts:
Curry, once again is the leader among top scorers in effective shooting and the only one over 60%
Antetokounmpo is only slightly behind despite being a very poor 3-point shooter. If he can improve his distance shooting, he may become unstoppable
Russell Westbrook, once again, had the worst effective shooting percent of anyone who averaged 20 points or more. In fact, he was significantly below the league average. Part of the reason is despite being a very poor 3-point shooter he continues to take too many distance shots. Whereas most players find that taking 3s increases their effective shooting percent, for Westbrook it lowers it. I haven’t been able to check this, but one broadcaster stated that he has the lowest 3-point percentage of any player in history that has taken over 2500 3-point shots!
I believe that Westbrook has a diminished chance to accumulate as many triple doubles next season as he has in the past. There is only one ball and both he and Harden tend to hold it most of the time. When Chris Paul came to the Rockets his assists per game decreased by about 15% compared to his prior 3 season average.

How to Improve Contribution Margin

November 5, 2018 Mike Kwatinetz Ecommerce, Golden State Warriors, KPI, Marketing, Metrics, NBA, Technology

This post is the third in my series on Key Performance Indicators (KPIs), with a heavy emphasis on contribution margin (CM). Previously, I analyzed why CM is such a strong predictor of success. Given that, companies should consistently look at ways of improving it while still maintaining sufficient growth in their business.

In Azure’s recent full day marketing seminar for our consumer (B2C) focused companies, my session highlighted 6 methods of improving CM:

Increase follow-on sales from existing customers
Raise the average invoice value of the initial and subsequent sales to a customer
Increase GM (Gross Margin) through price increases
Increase GM by reducing cost of goods sold (COGs)
Reduce Blended CAC (cost of customer acquisition) by increasing free or very low cost traffic
Decrease marketing spend as a % of revenue

Before drilling down on each of these I want to define several key terms that will be used throughout the discussion:

Contribution Margin = GM – Marketing/Sales Costs – other cost that vary with sales
Paid CAC = Market Spend/New Customers acquired through this spend
Blended CAC = Market Spend/All new customers
CAC Recovery Time (CAC RT) = the number of months until variable profit on a customer equals CAC
LTV/CAC = Life Time Value (LTV) of a customer/CAC

I will now review each of these strategies and provide some thoughts on how to activate these in consumer-facing businesses:

1. Increase Follow-On sales from existing customers

Since existing customers have little or no cost associated with getting them to buy, this will decrease blended CAC, increasing CM.

Increasing customer retention through improvements in customer care, more interesting and more targeted emails to a customer, or launching a subscription of one kind or another can all help.

On the first point here is an email I received shortly after subscribing to Harry’s, that I thought did an excellent job at engaging me with their customer support, increasing my likelihood to keep my subscription active:

Hi there,

My name is Katie, and I’m a member of the Harry’s team. I wanted to reach out and say thanks for supporting Harry’s.

You are important to us, and I am here to personally help you however I can to make your Harry’s experience as smooth as possible – both literally and figuratively. Please don’t hesitate to reach out with any thoughts or questions about your Harry’s products or Shave Plan, or just life in general. (And just a reminder that your next box is scheduled to ship on October 27th.) Thanks again for your support, and I hope to speak soon!

All the best,
Katie

On the subscription concept, think about Amazon Prime. How many of you buy more frequently from Amazon because of being a prime member?

Add to product portfolio. By giving your customers more options of what to buy (all within the concept of your brand) customers are given the opportunity to spend more often.
Make sure your emails are interesting. This will increase the open rate and drive more follow on sales. If all your emails are about discounting your product, then customers will have less interest in opening them and your brand will be devalued. I’ve received emails from numerous sites that say an X% discount is available until a certain date, and then when that date passes, I receive a new offer that is the same or sometimes better. The most frequently opened emails have headers and content that creates interest beyond whatever products you sell. A/B test different headers and different content. It doesn’t matter how small or large you are or how many emails you send, it always pays to try different variations to increase open rates and conversion. Experiment with different messaging to different customer segments like those who purchased recently, those who “liked” an item, those that have never purchased, etc.
Build a Community of your customers. The more you can get customers engaged with you and with each other, the more committed to you they become and the longer they are retained. Think through how you can build an active community among your users through shared photos, videos, chatting, podcasts or events. Most of this should not involve trying to push new purchases but engaging your community to interact with you and each other.

2. Raise the average invoice value of the initial and subsequent sales to a customer

Since shipping costs will not increase proportionately, this will raise GM dollars and therefore CM.

Increase pricing. Most startups underprice their product thinking that will increase market adoption. Even some of the largest companies in the world have found there was ample room to increase prices. Thinking differently, Apple upped prices to over $1,000 for an iPhone. And then increased it again to $1,349 for the top of the line product. Five years ago, how many of you thought people would pay over $1,000 for a cell phone? This shows that unless you A/B test different price points you have no idea whether a price increase is the right strategy.
Upsell logical add-on products. While trying to get a customer to add to their shopping cart may seem obvious, many companies do not do this on a consistent basis. Some examples of ones that have: a flower company added vases to the offer, a mattress company added pillows and sheets; a subscription razor company added shaving gel; a cell phone company added a case. All of these led to reasonable attach rates of the add-on product and higher average invoice value. Testing what you could add to generate upsell should be a constant process.
“Selling” value added services is another form of upsell. This could include things like concierge customer service, service contacts, premier membership with benefits like: invites to special events, early access to new products, reduced shipping cost, preferred discounts on products, etc. If you get your customers to engage in one or more services, you will significantly increase their connection to your product and likely increase retention.

3. Increase Gross Margin through price Increases

Surprisingly, sometimes higher prices position a product as premium (having more value) and generate increased unit sales. Often higher prices generate more revenue even when fewer unit sales result. What may be counter intuitive is that GM$ can increase even if revenue declines. For example, suppose a company has COGs of $50 for a product and is currently pricing it at $100. If a price increase of 20% causes 20% lower unit sales, revenue would decline by 4% while GM$ would increase 12%. Higher gross margin dollars provide more ability to spend on marketing.

4. Improving GM by reducing COGs

Better Pricing: When your volume increases, ask for better pricing from suppliers. Just as its important to price test regularly, its also important to talk to multiple potential suppliers of your parts/product. An existing supplier may not be eager to voluntarily offer a price discount that goes with increased volume but is more likely to do so if it knows you are checking with others.
Changing Packaging: Packaging should be re-examined regularly as improvements may help customer retention. But it also may be possible to lower the cost of the packaging or to change it in a way that lowers shipping costs since that may be based on the size of the box rather than weight.
Shipping Costs: Lower shipping cost per $ of revenue (increasing GM and CM) by generating larger orders. In addition to upsell, this can be done by offering better discounts if the order size is larger. One site I have purchased from offers 10% discount if your net spend (after discount) is over $100, 15% if over $150 and 20% if over $200. Getting to the highest discount lowers the price of the product by enough to motivate buyers (including me) to try to buy over $200 in merchandise. The extra revenue creates incremental product margin dollars and decreases shipping cost as a percentage of revenue. This in turn increases GM$.

For a subscription company this can be done by scheduling less frequent (larger) deliveries. The shipping cost of the larger order will be a much smaller percent of revenue, raising GM.

Opening a Second distribution center to reduce shipping cost. Orders shipped from a west coast distribution center to an east coast customer will have 5 zone pricing. By having a second distribution center in a place like Columbus, Ohio (a frequently used location) those same orders will usually be 1 zone, sometimes 2 zone pricing, resulting in substantial savings per order. The caveat here is that a company needs enough volume for the total savings on orders to exceed the fixed cost of a second distribution center.

5. Improving CM by driving “free” or “nearly free” traffic

The higher the proportion of free or inexpensive traffic to total traffic, the lower the blended CAC.

Improving SEO (search engine optimization). I’ve learned from SEO experts that optimizing SEO is not free, but rather very low cost compared to paid traffic. Our previous post walks through some of the science involved in making improvements. I would suggest using an SEO consultant as it is likely to lead to far better results.
Convert a visitor not ready to buy to an email recipient. If you do that than you will have subsequent opportunities to market to her or him. A slightly costlier version of this is to use remarketing to woo visitors who came to your site but didn’t buy. While using remarketing (advertising) has a cost, it is usually much lower CAC than other methods.
Produce emails that get forwarded and go viral. Such emails need to motivate recipients to forward them due to being very funny, of human interest, etc. While there is typically a product offering embedded in them, the header emphasizes the reason to read it. One Azure portfolio company, Shinesty, recently had an email that was opened by about 7X the number of people it was initially sent to. That generated a lot of potential customers without spending extra marketing dollars. Engaging emails has enabled Shinesty to maintain high CM and high growth.
Use social networking to generate incremental customers. Having the right posts on a social network like Instagram can lead to new potential customers finding out about you and lead to additional sales.
Optimize Customer Retention. Or as my good friend Chris Bruzzo (CMO of EA) spoke about at the Azure Marketing conference: “Love the ones you’re with.” Existing customers are usually the largest source of “free” buyers in a period. The longer you retain a customer, the more repeat buyers you have, increasing contribution margin. So, it’s imperative to take great care of your existing customers.
Drive PR. Like SEO, there is some cost involved in this but if you are judicious in any agency spend and thoughtful in creating news worthy press releases this can be a great source of traffic at a modest cost. However, I recommend you try to understand what you are getting from PR because I have seen situations where the spend did not produce meaningful results.

6. Decrease Marketing Spend as a % of Revenue.

The CAC Recovery Time plays a major role in how to manage your market spend to balance growth and burn. For example, if CAC Recovery Time is one month, spending more will not drive up burn appreciably. If it takes more than a year to recover your CAC, moderating market spend is critical to achieving a reasonable CM. If you recoup CAC faster, you can invest more quickly in the next round of customers. In the consumer space, I won’t invest in a company that has a long (a year or more) CAC Recovery Time as customers are likely to churn in an average of 2-3 years, making it difficult to achieve a reasonable business model. For B2B company’s customer longevity tends to be much longer, and the LTV/CAC can be 5X or more even if CAC Recovery Time is a year.

When a company decreases its market spend as a % of revenue it may experience lower growth but better CM. However, many companies have waste in their marketing spend so it’s important to measure the efficacy of each area of spend separately and to eliminate programs with a low return. This will allow you to reduce the spend with minimal impact on growth rates. There is a balance needed to try to optimize the relationship between CM and revenue growth as higher burn requires raising money more frequently and can put your company at risk. On the other hand, a company generating $1M in revenue needs to be growing at 100% or more to warrant most VCs to consider investing. Since CM should improve with scale, spending more on marketing may be a viable strategy for early stage companies. Once a company reaches $10M in revenue, annual growth of 50% will get it to $76M in revenue in 5 years so such a company should consider better CM rather than driving much higher growth rates and continuing to burn excessive cash.

In summary, Contribution Margin is the lifeblood of a company. If it is weak, the company is likely to fail over time. If it is strong and revenue growth is high, success seems likely. Improving CM is an ongoing process. I realize many of you probably feel much of what I’ve said is obvious, but my question is:“How many of these suggestions are you already doing on a regular basis?”

While you may be using several of the suggestions in this post, I encourage you to try more and to also double down where you can on the ones you already are trying. The results will make your company more valuable!

SoundBytes

I just want to remind readers that my collaborator on my blog posts, Andrea Drager, doesn’t typically take a bow for her significant contributions. Also, in this post, Chris Bruzzo added several improvements that have been incorporated. So many thanks to Andrea and Chris.
Can’t help but comment on the start to the NBA season. Not surprisingly, the Warriors are off to a great start with Curry and Durant leading the way. Greene and Thompson now have moved close to their usual contribution so I’m hopeful that the team can keep up its current pace.
What surprised me early on was the lack of recognition that both Toronto and San Antonio would be greatly improved. Remember, while San Antonio lost Kawhi, he only played a few games last year so with the addition of DeRozan should improve and once again reach the playoffs. For Toronto the change to Kawhi is a marked improvement placing them very competitive with the Celtics for eastern leadership.
I also feel it necessary to comment on the “Las Vegas” Raiders. I call them that already as they have shown zero regard for Oakland fans. While commentators have criticized their trading of all-star level players for draft choices, this is precisely on-strategy. When they get to Vegas they want a brand-new set of rising stars that the new fan base can identify with (using the numerous first round draft choices they traded for), and they don’t mind having the worst record in the league while still in Oakland. I believe Oakland fans should stop attending games as a response. I also think the NFL continues to shoot itself in the foot, allowing one of the most loyal and visible fan bases in the league to once again be abandoned

The Valuation Bible

February 22, 2018February 22, 2018 Mike Kwatinetz Ecommerce, Economics, Golden State Warriors, Metrics, NBA, Stocks, Technology, Valuation Blue Apron, Ecommerce, Economics, Golden State Warriors, Startups, Stephen Curry, Stocks, Valuation

After many years of successfully picking public and private companies to invest in, I thought I’d share some of the core fundamentals I use to think about how a company should be valued. Let me start by saying numerous companies defy the logic that I will lay out in this post, often for good reasons, sometimes for poor ones. However, eventually most companies will likely approach this method, so it should at least be used as a sanity check against valuations.

When a company is young, it may not have any earnings at all, or it may be at an earnings level (relative to revenue) that is expected to rise. In this post, I’ll start by considering more mature companies that are approaching their long-term model for earnings to establish a framework, before addressing how this framework applies to less mature companies. The post will be followed by another one where I apply the rules to Tesla and discuss how it carries over into private companies.

Growth and Earnings are the Starting Points for Valuing Mature Companies

When a company is public, the most frequently cited metric for valuation is its price to earnings ratio (PE). This may be done based on either a trailing 12 months or a forward 12 months. In classic finance theory a company should be valued based on the present value of future cash flows. What this leads to is our first rule:

Rule 1: Higher Growth Rates should result in a higher PE ratio.

When I was on Wall Street, I studied hundreds of growth companies (this analysis does not apply to cyclical companies) over the prior 10-year period and found that there was a very strong correlation between a given year’s revenue growth rate and the next year’s revenue growth rate. While the growth rate usually declined year over year if it was over 10%, on average this decline was less than 20% of the prior year’s growth rate. What this means is that if we took a group of companies with a revenue growth rate of 40% this year, the average organic growth for the group would likely be about 33%-38% the next year. Of course, things like recessions, major new product releases, tax changes, and more could impact this, but over a lengthy period of time this tended to be a good sanity test. As of January 2, 2018, the average S&P company had a PE ratio of 25 on trailing earnings and was growing revenue at 5% per year. Rule 1 implies that companies growing faster should have higher PEs and those growing slower, lower PEs than the average.

Graph 1: Growth Rates vs. Price Earnings Ratios

The graph shows the correlation between growth and PE based on the valuations of 21 public companies. Based on Rule 1, those above the line may be relatively under-priced and those below relatively over-priced. I say ‘may be’ as there are many other factors to consider, and the above is only one of several ways to value companies. Notice that most of the theoretically over-priced companies with growth rates of under 5% are traditional companies that have long histories of success and pay a dividend. What may be the case is that it takes several years for the market to adjust to their changed circumstances or they may be valued based on the return from the dividend. For example, is Coca Cola trading on: past glory, its 3.5% dividend, or is there something about current earnings that is deceptive (revenue growth has been a problem for several years as people switch from soda to healthier drinks)? I am not up to speed enough to know the answer. Those above the line may be buys despite appearing to be highly valued by other measures.

Relatively early in my career (in 1993-1995) I applied this theory to make one of my best calls on Wall Street: “Buy Dell sell Kellogg”. At the time Dell was growing revenue over 50% per year and Kellogg was struggling to grow it over 4% annually (its compounded growth from 1992 to 1995, this was partly based on price increases). Yet Dell’s PE was about half that of Kellogg and well below the S&P average. So, the call, while radical at the time, was an obvious consequence of Rule 1. Fortunately for me, Dell’s stock appreciated over 65X from January 1993 to January 2000 (and well over 100X while I had it as a top pick) while Kellogg, despite large appreciation in the overall stock market, saw its stock decline slightly over the same 7-year period (but holders did receive annual dividends).

Rule 2: Predictability of Revenue and Earnings Growth should drive a higher trailing PE

Investors place a great deal of value on predictability of growth and earnings, which is why companies with subscription/SaaS models tend to get higher multiples than those with regular sales models. It is also why companies with large sales backlogs usually get additional value. In both cases, investors can more readily value the companies on forward earnings since they are more predictable.

Rule 3: Market Opportunity should impact the Valuation of Emerging Leaders

When one considers why high growth rates might persist, the size of the market opportunity should be viewed as a major factor. The trick here is to make sure the market being considered is really the appropriate one for that company. In the early 1990s, Dell had a relatively small share of a rapidly growing PC market. Given its competitive advantages, I expected Dell to gain share in this mushrooming market. At the same time, Kellogg had a stable share of a relatively flat cereal market, hardly a formula for growth. In recent times, I have consistently recommended Facebook in this blog for the very same reasons I had recommended Dell: in 2013, Facebook had a modest share of the online advertising, a market expected to grow rapidly. Given the advantages Facebook had (and they were apparent as I saw every Azure ecommerce portfolio company moving a large portion of marketing spend to Facebook), it was relatively easy for me to realize that Facebook would rapidly gain share. During the time I’ve owned it and recommended it, this has worked out well as the share price is up over 8X.

How the rules can be applied to companies that are pre-profit

As a VC, it is important to evaluate what companies should be valued at well before they are profitable. While this is nearly impossible to do when we first invest (and won’t be covered in this post), it is feasible to get a realistic range when an offer comes in to acquire a portfolio company that has started to mature. Since they are not profitable, how can I apply a PE ratio?

What needs to be done is to try to forecast eventual profitability when the company matures. A first step is to see where current gross margins are and to understand whether they can realistically increase. The word realistic is the key one here. For example, if a young ecommerce company currently has one distribution center on the west coast, like our portfolio company Le Tote, the impact on shipping costs of adding a second eastern distribution center can be modeled based on current customer locations and known shipping rates from each distribution center. Such modeling, in the case of Le Tote, shows that gross margins will increase 5%-7% once the second distribution center is fully functional. On the other hand, a company that builds revenue city by city, like food service providers, may have little opportunity to save on shipping.

Calculating variable Profit Margin

Once the forecast range for “mature” gross margin is estimated, the next step is to identify other costs that will increase in some proportion to revenue. For example, if a company is an ecommerce company that acquires most of its new customers through Facebook, Google and other advertising and has high churn, the spend on customer acquisition may continue to increase in direct proportion to revenue. Similarly, if customer service needs to be labor intensive, this can also be a variable cost. So, the next step in the process is to access where one expects the “variable profit margin” to wind up. While I don’t know the company well, this appears to be a significant issue for Blue Apron: marketing and cost of goods add up to about 90% of revenue. I suspect that customer support probably eats up (no pun intended) 5-10% of what is left, putting variable margins very close to zero. If I assume that the company can eventually generate 10% variable profit margin (which is giving it credit for strong execution), it would need to reach about $4 billion in annual revenue to reach break-even if other costs (product, technology and G&A) do not increase. That means increasing revenue nearly 5-fold. At their current YTD growth rate this would take 9 years and explains why the stock has a low valuation.

Estimating Long Term Net Margin

Once the variable profit margin is determined, the next step would be to estimate what the long-term ratio of all other operating cost might be as a percent of revenue. Using this estimate I can determine a Theoretic Net Earnings Percent. Applying this percent to current (or next years) revenue yields a Theoretic Earnings and a Theoretic PE (TPE):

TPE= Market Cap/Theoretic Earnings

To give you a sense of how I successfully use this, review my recap of the Top Ten Predictions from 2017 where I correctly predicted that Spotify would not go public last year despite strong top line growth as it was hard to see how its business model could support more than 2% or so positive operating margin, and that required renegotiating royalty deals with record labels. Now that Spotify has successfully negotiated a 3% lower royalty rate from several of the labels, it appears that the 16% gross margins in 2016 could rise to 19% or more by the end of 2018. This means that variable margins (after marketing cost) might be 6%. This would narrow its losses, but still means it might be several years before the company achieves the 2% operating margins discussed in that post. As a result, Spotify appears headed for a non-traditional IPO, clearly fearing that portfolio managers would not be likely to value it at its private valuation price since that would lead to a TPE of over 200. Since Spotify is loved by many consumers, individuals might be willing to overpay relative to my valuation analysis.

Our next post will pick up this theme by walking through why this leads me to believe Tesla continues to have upside, and then discussing how entrepreneurs should view exit opportunities.

SoundBytes

I’ve often written about effective shooting percentage relative to Stephen Curry, and once again he leads the league among players who average 15 points or more per game. What also accounts for the Warriors success is the effective shooting of Klay Thompson, who is 3^rd in the league, and Kevin Durant who is 6^th. Not surprisingly, Lebron is also in the top 10 (4^th). The table below shows the top ten among players averaging 15 points or more per game. Of the top ten scorers in the league, 6 are among the top 10 effective shooters with James Harden only slightly behind at 54.8%. The remaining 3 are Cousins (53.0%), Lillard (52.2%), and Westbrook, the only one below the league average of 52.1% at 47.4%.

Table: Top Ten Effective Shooters in the League

*Note: Bolded players denote those in the top 10 in Points per Game

Re-cap of 2017 Top Ten Predictions

January 5, 2018 Mike Kwatinetz Ecommerce, Golden State Warriors, Metrics, Predictions, Stocks, Technology Amazon, Megabots, Omnichannel Sales, Predictions, Stocks, Whole Foods

I started 2017 by saying:

“When I was on Wall Street I became very boring by having the same three strong buy recommendations for many years… until I downgraded Compaq in 1998 (it was about 30X the original price at that point). The other two, Microsoft and Dell, remained strong recommendations until I left Wall Street in 2000. At the time, they were each well over 100X the price of my original recommendation. I mention this because my favorite stocks for this blog include Facebook and Tesla for the 4th year in a row. They are both over 5X what I paid for them in 2013 ($23 and $45, respectively) and I continue to own both. Will they get to 100X or more? This is not likely, as companies like them have had much higher valuations when going public compared with Microsoft or Dell, but I believe they continue to offer strong upside, as explained below.”

Be advised that my top ten for 2018 will continue to include all three picks from 2017. I’m quite pleased that I continue to be fortunate, as the three were up an average of 53% in 2017. Furthermore, each of my top ten forecasts proved pretty accurate, as well!

I’ve listed in bold the 2017 stock picks and trend forecasts below, and give a personal evaluation of how I fared on each. For context, the S&P was up 19% and the Nasdaq 28% in 2017.

Tesla stock appreciation will continue to outpace the market. Tesla, once again, posted very strong performance. While the Model 3 experienced considerable delays, backorders for it continued to climb as ratings were very strong. As of mid-August, Tesla was adding a net of 1,800 orders per day and I believe it probably closed the year at over a 500,000-unit backlog. So, while the stock tailed off a bit from its high ($385 in September), it was up 45% from January 3, 2017 to January 2, 2018 and ended the year at 7 times the original price I paid in 2013 when I started recommending it. Its competitors are working hard to catch up, but they are still trailing by quite a bit.
Facebook stock appreciation will continue to outpace the market. Facebook stock appreciated 57% year/year and opened on January 2, 2018 at $182 (nearly 8 times my original price paid in 2013 when I started recommending it). This was on the heels of 47% revenue growth (through 3 quarters) and even higher earnings growth.
Amazon stock appreciation will outpace the market. Amazon stock appreciated 57% in 2017 and opened on January 2, 2018 at $1,188 per share. It had been on my recommended list in 2015 when it appreciated 137%. Taking it off in 2016 was based on Amazon’s stock price getting a bit ahead of itself (and revenue did catch up that year growing 25% while the stock was only up about 12%). In 2017, the company increased its growth rate (even before the acquisition of Whole Foods) and appeared to consolidate its ability to dominate online retail.
Both online and offline retailers will increasingly use an omnichannel approach. Traditional retailers started accelerating the pace at which they attempted to blend online and offline in 2017. Walmart led, finally realizing it had to step up its game to compete with Amazon. While its biggest acquisition was Jet.com for over $3 billion, it also acquired Bonobos, Modcloth.com, Moosejaw, Shoebuy.com and Hayneedle.com, creating a portfolio of online brands that could also be sold offline. Target focused on becoming a leader in one-day delivery by acquiring Shipt and Grand Junction, two leaders in home delivery. While I had not predicted anything as large as a Whole Foods acquisition for Amazon, I did forecast that they would increase their footprint of physical locations (see October 2016 Soundbytes). The strategy for online brands to open “Guide” brick and mortar stores ( e.g. Tesla, Warby Parker, Everlane, etc.) continued at a rapid pace.
A giant piloted robot will be demo’d as the next form of entertainment. As expected, Azure portfolio company, Megabots, delivered on this forecast by staging an international fight with a giant robot from Japan. The fight was not live as the robots are still “temperamental” (meaning they occasionally stop working during combat). However, interest in this new form of entertainment was incredible as the video of the fight garnered over 5 million views (which is in the range of an average prime-time TV show). There is still a large amount of work to be done to convert this to an ongoing form of entertainment, but all the ingredients are there.
Virtual and Augmented reality products will escalate. Sales of VR/AR headsets appear to have well exceeded 10 million units for the year with some market gain for higher-end products. The types of applications have expanded from gaming to room design (and viewing), travel, inventory management, education, healthcare, entertainment and more. While the actual growth in unit sales fell short of what many expected, it still was substantial. With Apple’s acquisition of Vrvana (augmented reality headset maker) it seems clear that Apple plans to launch multiple products in the category over the next 2-3 years, and with Facebook’s launch of ArKIT, it’s social AR development platform, there is clearly a lot of focus and growth ahead.
Magic Leap will disappoint in 2017. Magic Leap, after 5 years of development and $1.5 billion of investment, did not launch a product in 2017. But, in late December they announced that their first product will launch in 2018. Once again, the company has made strong claims for what its product will do, and some have said early adopters (at a very hefty price likely to be in the $1,500 range) are said to be like those who bought the first iPod. So, while it disappointed in 2017, it is difficult to tell whether or not this will eventually be a winning company as it’s hard to separate hype from reality.
Cable companies will see a slide in adoption. According to eMarketer, “cord cutting”, i.e. getting rid of cable, reached record proportions in 2017, well exceeding their prior forecast. Just as worrisome to providers, the average time watching TV dropped as well, implying decreased dependence on traditional consumption. Given the increase now evident in cord cutting, UBS (as I did a year ago) is now forecasting substantial acceleration of the decline in subscribers. While the number of subscribers bounced around a bit between 2011 and 2015, when all was said and done, the aggregate drop in that four-year period was less than 0.02%. UBS now forecasts that between the end of 2016 and the end of 2018 the drop will be 7.3%. The more the industry tries to offset the drop by price increases, the more they will accelerate the pace of cord cutting.
Spotify will either postpone its IPO or have a disappointing one. When we made this forecast, Spotify was expected to go public in Q2 2017. Spotify postponed its IPO into 2018 while working on new contracts with the major music labels to try to improve its business model. It was successful in these negotiations in that the labels all agreed to new terms. Since the terms were not announced, we’ll need to see financials for Q1 2018 to better understand the magnitude of improvement. In the first half of the year, Spotify reported that gross margins improved from 16% to 22%, but this merely cut its loss level rather than move the company to profitability. It has stated that it expects to do a non-traditional IPO (a direct listing without using an investment bank) in the first half of 2018. If the valuation approaches its last private round, I would caution investors to stay away, as that valuation, coupled with 22% gross margins (and over 12% of revenue in sales and marketing cost to acquire customers), implies net margin in the mid-single digits at best (assuming they can reduce R&D and G&A as a percent of revenue). This becomes much more challenging in the face of a $1.6 billion lawsuit filed against it for illegally offering songs without compensating the music publisher. Even if they managed to successfully fight the lawsuit and improve margin, Spotify would be valued at close to 100 times “potential earnings” and these earnings may not even materialize.
Amazon’s Echo will gain considerable traction in 2017. Sales of the Echo exploded in 2017 with Amazon announcing that it “sold 10s of millions of Alexa-enabled devices” exceeding our aggressive forecast of 2-3x the 4.4 million units sold in 2016. The Alexa app was also the top app for both Android and iOS phones. It clearly has carved out a niche as a new major platform.

Stay tuned for my top 10 predictions of 2018!

SoundBytes

In our December 20, 2017 post, I discussed just how much Steph Curry improves teammate performance and how effective a shooter he is. I also mentioned that Russell Westbrook leading the league in scoring in the prior season might have been detrimental to his team as his shooting percentage falls well below the league average. Now, in his first game returning to the lineup, Curry had an effective shooting percentage that exceeded 100% while scoring 38 points (this means scoring more than 2 points for every shot taken). It would be interesting to know if Curry is the first player ever to score over 35 points with an effective shooting percentage above 100%! Also, as of now, the Warriors are scoring over 15 points more per game this season with Curry in the lineup than they did for the 11 games he was out (which directly ties to the 7.4% improvement in field goal percentage that his teammates achieve when playing with Curry as discussed in the post).

Ending the Year on a High Note…or should I say Basketball Note

December 20, 2017December 20, 2017 Mike Kwatinetz Golden State Warriors, Metrics, NBA, Sports Golden State Warriors, NBA, Russell Westbrook, Stephen Curry

Deeper analysis on what constitutes MVP Value

In my blog post dated February 3, 2017, I discussed several statistics that are noteworthy in analyzing how much a basketball player contributes to his team’s success. In it, I compared Stephen Curry and Russell Westbrook using several advanced statistics that are not typically highlighted.

The first statistic: Primary plus Secondary Assists per Minute a player has the ball. Time with the ball equates to assist opportunity, so holding the ball most of the time one’s team is on offense reduces the opportunity for others on the team to have assists. This may lead to fewer assisted baskets for the whole team, but more for the individual player. As of the time of the post, Curry had 1.74 assists (primary plus secondary) per minute he had the ball, while Westbrook only had 1.30 assists per minute. Curry’s efficiency in assists is one of the reasons the Warriors total almost 50% more assists per game than the Thunder, make many more easy baskets, and lead the league in field goal percentage.

The second statistic: Effective Field Goal Percentages (where making a 3-point shot counts the same as making 1 ½ 2-point shots). Again, Curry was vastly superior to Westbrook at 59.1% vs 46.4%. What this means is that Westbrook scores more because he takes many more shots, but these shots are not very efficient for his team, as Westbrook’s shooting percentage continued to be well below the league average of 45.7% (Westbrook’s was 42.5% last season and is 39.6% this season to date).

The third statistic: Plus/Minus. Plus/Minus reflects the number of points your team outscores opponents while you are on the floor. Curry led the league in this in 2013, 2014, and 2016 and leads year-to-date this season. In 2015 he finished second by a hair to a teammate. Westbrook has had positive results, but last year averaged 3.2 per 36 minutes vs Curry’s 13.8. One challenge to the impressiveness of this statistic for Curry is whether his leading the league in Plus/Minus is due to the quality of players around him. In refute, it is interesting to note that he led the league in 2013 when Greene was a sub, Durant wasn’t on the team and Thompson was not the player he is today.

The background shown above brings me to today’s post which outlines another way of looking at a player’s value. The measurement I’m advocating is: How much does he help teammates improve? My thesis is that if the key player on a team creates a culture of passing the ball and setting up teammates, everyone benefits. Currently the value of helping teammates is only measured by the number of assists a player records. But, if I’m right, and the volume of assists is the wrong measure of helping teammates excel (as sometimes assists are the result of holding the ball most of the time) then I should be able to verify this through teammate performance. If most players improve their performance by getting easier shots when playing with Westbrook or Curry, then this should translate into a better shooting percentage. That would mean we should be able to see that most teammates who played on another team the year before or the year after would show a distinct improvement in shooting percentage while on his team. This is unlikely to apply across the board as some players get better or worse from year to year, and other players on one’s team also impact this data. That being said, looking at this across players that switch teams is relevant, especially if there is a consistent trend.

To measure this for Russell Westbrook, I’ve chosen 5 of the most prominent players that recently switched teams to or from Oklahoma City: Victor Oladipo, Kevin Durant, Carmelo Anthony, Paul George and Enes Kantor. Three left Oklahoma City and two went there from another team. For the two that went there, Paul George and Carmelo Anthony, I’ll compare year-to-date this season (playing with Westbrook) vs their shooting percentage last year (without Westbrook). For Kantor and Oladipo, the percentage last year will be titled “with Westbrook” and this year “without Westbrook” and for Durant, the seasons in question are the 2015-16 season (with Westbrook) vs the 2016-17 season (without Westbrook).

Shooting Percentage

Given that the league average is to shoot 45.7%, shooting below that can hurt a team, while shooting above that should help. An average team takes 85.4 shots per game, so a 4.0% swing translates to over 8.0 points a game. To put that in perspective, the three teams with the best records this season are the Rockets, Warriors and Celtics and they had first, second and fourth best Plus/Minus for the season at +11.0, +11.0 and +5.9, respectively. The Thunder came in at plus 0.8. If they scored 8 more points a game (without giving up more) their Plus/Minus would have been on a par with the top three teams, and their record likely would be quite a bit better than 12 and 14.

Curry and His Teammates Make Others Better

How does Curry compare? Let’s look at the same statistics for Durant, Andrew Bogut, Harrison Barnes, Zaza Pachulia and Ian Clark (the primary player who left the Warriors). For Barnes, Bogut, Pachulia and Durant I’ll compare the 2015 and 2016 seasons and for Clark I’ll use 2016 vs this season-to-date.

So, besides being one of the best shooters to play the game, Curry also has a dramatic impact on the efficiency of other players on his team. Perhaps it’s because opponents need to double team him, which allows other players to be less guarded. Perhaps it’s because he bought into Kerr’s “spread the floor, move the ball philosophy”. Whatever the case, his willingness to give up the ball certainly has an impact. And that impact, plus his own shooting efficiency, clearly leads to the Warriors being an impressive scoring machine. As an aside, recent Warrior additions Casspi and Young are also having the best shooting percentages of their careers.

Westbrook is a Great Player Who Could be Even Better

I want to make it clear that I believe Russell Westbrook is a great player. His speed, agility and general athleticism allow him to do things that few other players can match. He can be extremely effective driving to the basket when it is done under control. But, he is not a great outside shooter and could help his team more by taking fewer outside shots and playing less one/one basketball. Many believed that the addition of George and Anthony would make Oklahoma City a force to be reckoned with, but to date this has not been the case. Despite the theoretic offensive power these three bring to the table, the team is 24^th in the league in scoring at 101.8 per game, 15 points per game behind the league leading Warriors. This may change over the course of the season but I believe that each of them playing less one/one basketball would help.

They got it right: Why Stephen Curry deserves to be a First Team All-Star

February 3, 2017February 3, 2017 Mike Kwatinetz Golden State Warriors, NBA, Sports Golden State Warriors, Russell Westbrook, Stephen Curry

Much has been written about the fact that Russell Westbrook was not chosen for the first team on the Western All-Stars. The implication appears to be that he was more deserving than Curry. I believe that Westbrook is one of the greatest athletes to play the game and one of the better players currently in the league. Yet, I also feel strongly that so much weight is being placed on his triple doubles that he is being unfairly anointed as the more deserving player. This post takes a deeper dive into the available data and, I believe, shows that Curry has a greater impact on winning games and is deserving of the first team honor. So, as is my want to analyze everything, I spent some time dissecting the comparison between the two. It is tricky comparing the greatest shooter to ever play the game to one of the greatest athletes to ever play, but I’ll attempt it, statistic by statistic.

Rebounding

Westbrook is probably the best rebounding guard of all time (with Oscar Robertson and Magic Johnson close behind). This season he is averaging 10.4 rebounds per game while Curry is at 4.3. There is no question that Westbrook wins hands down in this comparison with Curry, who is a reasonably good rebounding point guard. But on rebounds per 36 minutes played this season, Westbrook’s stats are even better than Oscar’s in his best year. In that year, Robertson averaged 12.5 rebounds playing over 44 minutes a game which equates to 10.2 per 36 minutes vs Westbrook’s 10.8 per 36 minutes (Magic never averaged 10 rebounds per game for a season).

Assists

You may be surprised when I say that Curry is a better assist producer than Westbrook this season. How can this be when Westbrook averages 10.3 assists per game and Curry only 6.2? Since Oklahoma City plays a very different style of offense than the Warriors, Westbrook has the ball in his hands a much larger percentage of the time. They both usually bring the ball up the court but once over half court, the difference is striking. Curry tends to pass it off a high proportion of the time while Westbrook holds onto it far longer. Because of the way Curry plays, he leads the league in secondary assists (passes that set up another player to make an assist) at 2.3 per game while Westbrook is 35^th in the league at 1.1 per game. The longer one holds the ball the more likely they will shoot it, commit a turnover or have an assist and the less likely they will get a secondary assist. The reason is that if they keep the ball until the 24 second clock has nearly run out before passing, the person they pass it to needs to shoot (even if the shot is a poor one) rather than try to set up someone else who has an easier shot. For example, if a player always had the ball for the first 20 seconds of the 24 second clock, they would likely have all assists for the team while on the court.

Table 1: Assist Statistic Comparison

Curry vs. Westbrook Assists — *NBA.com statistics average per game through Feb 1st, 2017

When in the game, Westbrook holds the ball about 50% of the time his team is on offense, he gets a large proportion of the team’s assists. But that style of play also means that the team winds up with fewer assists in total. In fact, while the Warriors rank #1 in assists as a team by a huge margin at 31.1 per game (Houston is second at 25.6), Oklahoma City is 20^th in the league at 21.2 per game. If you agree that the opportunity to get an assist increases with the number of minutes the ball is in the player’s possession, then an interesting statistic is the number of assists per minute that a player possesses the ball (see Table 1). If we compare the two players from that perspective, we see that Curry has 1.27 assists per minute and Westbrook 1.17. Curry also has 0.47 secondary assists per minute while Westbrook only 0.13. This brings the total primary and secondary assist comparison to 1.74 per minute of possession for Curry and 1.30 for Westbrook, a fairly substantial difference. It also helps understand why the Warriors average so many more assists per game than Oklahoma City and get many more easy baskets. This leads to them having the highest field goal percentage in the league, 50.1%.

Shooting

Russell Westbrook leads the league in scoring, yet his scoring is less valuable to his team than Stephen Curry’s is to the Warriors. This sounds counterintuitive but it is related to the shooting efficiency of the player: Curry is extremely efficient and Westbrook is inefficient as a shooter. To help understand the significance of this I’ll use an extreme example. Suppose the worst shooter on a team took every one of a team’s 80 shots in a game and made 30% of them including two 3-point shots. He would score 24 baskets and lead the league in scoring by a mile at over 50 points per game (assuming he also got a few foul shots). However, his team would only average 50 or so points per game and likely would lose every one of them. If, instead, he took 20 of the 80 shots and players who were 50% shooters had the opportunity to take the other 60, the team’s field goals would increase from 24 to 36. Westbrook’s case is not the extreme of our example but none-the-less Westbrook has the lowest efficiency of the 7 people on his team who play the most minutes. So, I believe his team overall would score more points if other players had more shooting opportunities. Let’s look at the numbers.

Table 2: Shot Statistic Comparison

shots-table — *NBA.com statistics average per game through Feb 1st, 2017

Westbrook’s shooting percentage of 42.0% is lower than the worst shooting team in the league, Memphis at 43.2%, and, as mentioned is the lowest of the 7 people on his team that play the most minutes. Curry has a 5.5% higher percentage than Westbrook. But the difference in their effectiveness is even greater as Curry makes far more three point shots. Effective shooting percentage adjusts for 3 point shots made by considering them equal to 1½ two point shots. Curry’s effective shooting percentage is 59.1% and Westbrook’s is 46.4%, an extraordinary difference. However, Westbrook gets to the foul line more often and “true shooting percent” takes that into account by assuming about 2.3 foul shots have replaced one field goal attempt (2.3 is used rather than 2.0 to account for 3 point plays and being fouled on a 3-point shot). Using the “true shooting percentage” brings Westbrook’s efficiency slightly closer to Curry’s, but it is still nearly 10% below Curry (see table 2). What this means is very simple – if Curry took as many shots as Westbrook he would score far more. In fact, at his efficiency level he would average 36.1 points per game versus Westbrook’s 30.7. While it is difficult to prove this, I believe if Westbrook reduced his number of shots Oklahoma City would score more points, as other players on his team, with a higher shooting percentage, would have the opportunity to shoot more. And he might be able to boost his efficiency as a shooter by eliminating some ill-advised shots.

Turnovers vs Steals

This comparison determines how many net possessions a player loses for his team by committing more turnovers than he has steals. Stephen Curry averages 2.9 turnovers and 1.7 steals per game, resulting in a net loss of 1.2 possessions per game. Russell Westbrook commits about 5.5 turnovers per game and has an average of 1.6 steals, resulting in a net loss of 3.9 possessions per game, over 3 times the amount for Curry.

Plus/Minus

In many ways, this statistic is the most important one as it measures how much more a player’s team scores than its opponents when that player is on the floor. However, the number is impacted by who else is on your team so the quality of your teammates clearly will contribute. Nonetheless, the total impact Curry has on a game through high effective shooting percent and assists/minute with the ball is certainly reflected in the average point differential for his team when he is on the floor. Curry leads the league in plus/minus for the season as his team averages 14.5 more points than its opponents per 36 minutes he plays. Westbrook’s total for the season is 41^st in the league and his team averages +3.4 points per 36 minutes.

Summing Up

While Russell Westbrook is certainly a worthy all-star, I believe that Stephen Curry deserves having been voted a starter (as does James Harden but I don’t think Harden’s selection has been questioned). Westbrook stands out as a great rebounding guard, but other aspects of his amazing triple double run are less remarkable when compared to Curry. Curry is a far more efficient scorer and any impartial analysis shows that he would average more points than Westbrook if he took the same number of shots. At the same time, Curry makes his teammates better by forcing opponents to space the floor, helping create more open shots for Durant, Thompson and others. He deserves some of the credit for Durant becoming a more efficient scorer this year than any time in his career. While Westbrook records a far larger number of assists per game than Curry, Curry is a more effective assist creator for the time he has the ball, helping the Warriors flirt with the 32-year-old record for team assists per game while Oklahoma City ranks 20^th of the 30 current NBA teams with 10 less assists per game than the Warriors.

An Analysis of Kevin Durant’s Free Agency Decision

June 29, 2016 Mike Kwatinetz Golden State Warriors, NBA, Sports

There is much controversy over whether Kevin Durant should leave OKC and if so, what team he best fits with. In evaluating what makes the most sense for him I’d like to cut through emotional clutter and start with objectives:

To be rated among the best ever, a basketball player needs to win championships – which is why LeBron James left Cleveland originally and why Bill Russell (8 championships) usually gets rated above Wilt Chamberlain (2 championships) despite the fact that Wilt was clearly a much more complete player and why you don’t typically see the great Patrick Ewing, Allen Iverson or Elgin Baylor (all 0 championships) getting ranked that high among the greatest players of the century .
When you win championships, people soon forget how stacked your team may or may not have been – LeBron is sometimes referred to as a failure in his first Cleveland stint despite taking the worst team in the league to the NBA finals and few talk about how good Michael Jordan’s supporting cast was in making the playoffs even when he was playing baseball instead of basketball.
I believe Durant understands that and his primary objective is to win championships so that he can rank higher among the greats.

How can he best accomplish that?

Kevin Durant could stay in OKC because of the emotional concept that it’s “his team” and he should not abandon them. The idea being that helping them win is somehow better than helping someone else win. If he does, his chance of winning a championship would be less than 12.5% (1 in 8) since they would probably need to beat San Antonio, Golden State and Cleveland and it’s hard to rate them as favorites in any of those matchups.
If Durant went to Golden State they would likely win the Western Conference again and have an easier schedule than a Durant led OKC could have in the playoffs. They are already the favorite to win the title even without Durant and the odds of them winning would increase significantly should they land him. Golden State is also a perfect fit for him as it plays a team game that would improve the quality of his shot opportunities. How does a team simultaneously double team Durant, Curry and Thompson? So not only would this increase his chance of winning, it also would likely increase his shooting percent and his assists.
The other team that he could pick with the best opportunity to win would be Cleveland but there is no cap space there and it’s unlikely that this would be a fit.
The third strong opportunity is San Antonio. While this would be a fit, the path to a title would not be as likely as Golden State or Cleveland because several key players are aging. However, adding Durant would create a strong trio that could challenge Golden State and possibly would be favored over them. But not the overwhelmingly favorites that the Warriors would be with Durant. Also going from one small market to another would not add the media draw that would lead to maximizing endorsement income.
Although there are rumors of Boston, Los Angeles, New York, Washington, Houston and Miami also courting Durant, none of these teams would solve any of his objectives. None would give him a high probability of winning a championship and would solve even less for the emotional component of the decision.
The question that was rattling around all year was “Why would the Warriors want Durant.” The answer is obvious and even more obvious after their game 7 loss – he will make them better. Adding one of the 5 best players in basketball, who shoots for a high percentage, plays defense well and is team oriented makes any team better.
What about the argument that adding Durant would use up so much cap space that the Warriors would need to shed other key players? I agree that they would not be able to keep Harrison Barnes and Festus Ezeli. But the reality is that Ezeli is not a key player and they should not match the high price he is likely to get in the free market, regardless of whether or not they get Durant. By Durant (and in the future Curry) taking less than a max salary, the Warriors could make sure that they kept Iguodala and Livingston plus all starters (including Andrew Bogut) other than Barnes. The rest of the team could be filled in and I would predict the Warriors could attract others who are willing to take lower salaries in order to be on a championship team. So, I suspect the remainder of the supporting cast will be as good as this year. If Durant is willing to take a salary that enables keeping the 6 key players mentioned, then he will maximize his chance of winning a title. When the cap goes up next year, he and Curry could take higher, but not maximum, salaries so that the team around them could continue to include Iguodala and Livingston.
What about the argument that Durant should maximize his compensation? My answer is that he will maximize his compensation by taking a lower salary and going to the Warriors because his endorsement money will increase by far more than any salary he forgoes since he would be playing on the highest profile team in a major market and winning championships. To quantify the opportunity, Michael Jordan made more in 2015 from endorsements (12 years after his last retirement) than he did in all 15 years in NBA earnings. Curry is already proving that and can easily take a lower than max salary when his contract expires in another year as his endorsements will dwarf his salary. And winning more championships will only increase all the key players’ outside revenue dramatically.

Next Gen Selling vs Old (or “Traditional”) Methods

December 9, 2015 Mike Kwatinetz Ecommerce, Golden State Warriors, NBA Ecommerce, Golden State Warriors, Omnichannel Sales, Stephen Curry

In this post I want to compare the buying experiences I’ve had recently when purchasing from an older generation company vs a newer one. I think it highlights the fact that ecommerce based models can create a much better buying experience than traditional brick and mortar sellers when coupled with a multi-channel approach. The two companies I want to highlight are Tesla (where my wife recently purchased a car) and Warby Parker (where I recently bought a pair of glasses). I’ll compare them to Mercedes and LensCrafters but you should understand it almost doesn’t matter which older gen companies I compared them to, so just consider the ones I’ve chosen (due to recent personal experience) as representative of their industries.

Controlling the buying experience

Warby Parker began opening retail “Guideshops” a few years ago. I recently went into one and was very pleased with the experience. They displayed all the frames they have and there were only two price categories which included the prescription lenses and the frames, $95 and $145. I selected a frame, went over to the desk and received assistance in completing the transaction. The person assisting me took one measurement of my eyes and then suggested I get slightly better lenses for a charge of $30 which I think was only necessary due to my particular prescription. There were no other charges, no salesperson, no other upsells, no waiting while the glasses are being made. Once I paid by credit card, the glasses were put in their cue to be made at their factory and shipped to my home within 10 days (with no shipping charge) and my receipt was sent by email rather than printed. From the time I entered the store until I left was about 10 minutes.

Compare this experience to buying a pair of glasses at LensCrafters. At LensCrafters the price range of frames is all over the map without any apparent reason except many carry a designer brand logo (but are unlikely to have been designed by that designer). To me the Warby Parker frames are as good or better looking as far more expensive ones at LensCrafters. Even if you select a frame at LensCrafters that costs $95-$300 or more, the lenses are not included. A salesperson then sits with you and begins the upselling process. Without going into all the details, suffice it to say that it is very difficult to discern what is really needed and therefore it is hard to walk out of the store without spending $100-$300 more than the cost of the frame. Further, since the glasses are made at the store you come back in a few hours to pick them up (of course this is a positive if you want them right away; I usually don’t care). I have typically spent well over an hour in the buying process plus going for a coffee for the 2 hours or so it took for them to make the lenses.

Tesla has been very adamant about owning and controlling their physical retail outlets rather than having their cars sold by independent dealerships. This gives them multiple advantages as they completely control the buying experience, eliminate competition between dealers, reduce distribution cost and can decide what the purpose of each location is and how it should look. They have also eliminated having cars to sell on the lot but instead use an ecommerce model where you order a car exactly the way you want it and it gets produced for you and brought to the Tesla physical location you want for pickup. Essentially, they have designed two types of physical stores: one that has a few demo models to enable test drives and one that also has a customer service department. This means that the latter is a much smaller size than a traditional car dealership (as it doesn’t need space for new car inventory on the lot) and the former is much smaller than that. The showroom approach occupies such a small footprint that Tesla has been able to locate showrooms in high foot traffic (high cost per foot) locations like malls. In their sites at the Stanford Mall and on Santana Row (two of the most expensive per square foot), Tesla kept the cars for test drives in the parking lots (at a fraction of the cost of store footage). When my wife decided to buy her second Tesla (trading in the older one) we spent about an hour at the dealer as there was no negotiation on price, the car could be configured to her exact specification on a screen at the dealership (or at home) and would be manufactured for her. There were no upsell attempts, no competing dealers to visit, and really no salesperson but rather a facilitator (much like at Warby Parker) that answered questions.

I bought my new car from Mercedes and had a much less pleasant buying experience. It starts with the fact that the price on the car isn’t the real price. This means that one needs to try to go to multiple dealers as well as online to get a better handle on what the real price is as the dealers are difficult to trust. Each dealer now has its own online person (or team) but this is actually still buying from a dealer. There is also a strong encouragement to buy a car in inventory (on the lot) and the idea of configuring the way one wants and ordering it is discouraged. The cars on the lot are frequently configured with costly (highly profitable) options that are unnecessary so that even with a discount from list one typically spends more than ordering it with only options you want and paying closer to list. After multiple days (and many, many hours) spent online and visiting dealerships I decided to replicate the Tesla concept and order a 2016 model to be built exactly how I wanted. Because I spent many hours shopping around, I still was able to get a price that was an extra $4,000 off list from what I had been offered if I bought a 2015 off the lot. The car was the color I wanted, only had the options I wanted and would have a higher resale value because of being a 2016. Since the list price had not increased and there were no unneeded options on the car I actually saved about $10,000 vs taking one off the lot with the lower discount even though all additional options I wanted were bundled with it.

Receiving the product

In the Warby Parker example, the glasses were shipped to my home in a very well designed box that enhanced their brand. The box contained an upscale case and a card that said: “For every pair of glasses sold, a pair is distributed to someone in need.” Buying at LensCrafters meant returning to the store for the glasses. The case included was a very cheap looking one (creating an upsell if one wanted a nicer case) and there was no packaging other than the case. However, I did get the glasses the same day and someone sat with me to make sure they fit well on my ears (fit was not an issue for me for the Warby Parker glasses but could be for some people).

On the automobile side, the car pickup at Tesla was a much better experience than the one at Mercedes. At Tesla, my wife and I spent a little over an hour at the pickup. We spent about 20 minutes on paperwork and 45 minutes getting a walk through on how various options on the car work. There were no attempts to upsell us on anything. At Mercedes the car pickup experience took nearly 4 hours and was very painful as over 3 hours of it was spent on paperwork and attempts at a variety of upsells. To be fair, we had decided to lease this car and that time occupied a portion of the paperwork. But the attempted upsells were extreme. The most ludicrous was trying to get us to buy an extended warranty when the included warranty exceeded the length of the lease. I could understand that it might be of value to some but, in our case, we told the lease person that we were only doing the lease so we wouldn’t own the car at the end of it. There were also upsells on various online services, and a number of other items. The time this took meant we did not have enough time left to go over all the features of the car. This process was clearly the way each person had been trained and was not a function of the particular people we dealt with. The actual salesperson who sold me the car was extremely nice but was working within a system that is not geared towards the customer experience as dealers can’t count on buyers returning even if they buy the same brand again.

Summary

There is a significant advantage being created by new models of doing business which control the complete distribution chain. Their physical locations have a much smaller footprint than traditional competitors which allow them to put their shops in high traffic locations without incurring commensurate cost. They consolidate inventory into a centralized location which reduces inventory cost, storage and obsolescence. They completely control the buying experience and understand that customer satisfaction leads to higher life time value of a customer.

SoundBytes

In my SoundByte post dated April 9, I discussed several of the metrics that caused me to conclude that Stephen Curry should be the 2014-15 season MVP. He subsequently received the award but it still appeared that many did not fully understand his value. I thought it was well captured in the post by looking at EFG, or effective shooting percentage (where a three point shot made counts as 1.5 two point shots made since its worth 50% more points), plus/minus and several other statistics not widely publicized. This year, Curry has become even better and I realized one other statistic might help highlight his value in an even better way, points created above the norm (PAN).

I define PAN as the extra points created versus an average NBA player through more effective shooting. It is calculated using this formula:

PAN= 2 x (the players average number of shots per game) x (players EFG- league norm EFG)

The league’s effective shooting percentage as of December 6 is 49.0%. Since Curry’s effective shooting percentage is 66.1% as of today date, the difference is 17.1%. Curry has been averaging 20.2 shots per game this year so his PAN = 2 x 20.2 x 17.1%= 6.9. This means Curry’s shooting alone (excluding foul shots) adds about 7 points per game to his team versus an average shooter. But, because Curry is unselfish and is often double teamed, he also contributes heavily to helping the team as a whole be more effective shooters. This leads to a team PAN of 14.0. Which means the Warriors score an extra 14 points a game due to more effective shooting.

Interestingly, when you compare this statistic to other league leaders and NBA stars, Curry’s contribution becomes even more remarkable. While Curry add about 7 points per game to his team versus an average shooter, James Harden, Dwayne Wade and Kobe Bryant are all contributing less than the average player. Given Curry’s wildly superior efficiency he is contributing almost twice as much as Kevin Durant.

With Curry’s far superior individual and team contribution to shooting efficiency, it is not surprising that the Warriors are outscoring their opponents by such record breaking margins.

To further emphasize how much Curry’s PAN impacts his team we compared him to Kobe Bryant. The difference in their PANs is 11.8 points per game. How much would it change the Lakers record if they had these extra 11.8 points per game and all else was equal? It would move the Lakers from the second worst point differential (only Philadelphia trails them) to 10^th in the league and 4^th among Western conference teams. Since point differential correlates closely to team record, that might mean the Lakers would be competing for home court in the playoffs instead of the worst record in the league!

Transforming Education

November 17, 2015November 17, 2015 Mike Kwatinetz Education, Education.com, Golden State Warriors, NBA

I was recently interviewed on NBC regarding education, market valuations and the accuracy of my forecasts of market trends made in 2001, among other things (www.pressheretv.com). Since the interview stimulated thoughts on the education market, I thought it was worth capturing a few in a post.

Why the quality of education in the United States trails

According to the World Bank, the United States leads the world in Gross Domestic Product, dwarfing anyone else. The U.S. GDP is 70 percent ahead of number 2 China, and almost 4 times the size of number 3, Japan. Given this wealth of resources, it is somewhat surprising just how low we rank in K-12 education among nations:

36th in mathematics for 15 year olds[1]
24th in reading for 15 year olds[1]
28th in science for 15 years olds[1]
14th in cognitive skills and educational attainment[2]
11th in fourth-grade mathematics and 9th in eighth-grade mathematics[3]
7th in fourth-grade science and 10th in eighth-grade science[3]

Part of the problem is that much of our priority as a country tends to emphasize short-term gratification over long-term issues such as investing in primary education. But the problem goes much deeper.

Classroom sizes have been increasing

Parents Across America, a non-profit organization committed to strengthening US public schools, point to studies that indicate that students (especially in grades K-3) who are assigned to smaller classes do better in every way that can be measured. Of 27 countries shown in a 2007 Organization of Economic Cooperation and Development (OECD) survey the United States ranked 17^th in lower education classroom size, at 24.3 students per class. While other countries are investing in reducing classroom size, the U.S. is going in the other direction. Of 26 countries included in the OECD data from 2000 and 2009, 25 either decreased classroom sizes or kept them about the same. The United States was the only one that increased classroom sizes during that period.

Heterogeneous grouping exasperates the problem

In years gone by, U.S. classrooms were homogenous, as children were separated according to their skill level. This practice came under heavy criticism because it was viewed as discriminatory. Throughout the United States, schools shifted to heterogeneous classes not because this technique was proven to be effective but rather in an effort to promote “political correctness.”

One teacher pointed out that “administrators love to boast that their school has heterogeneous grouping…but the administrators aren’t in the classroom, and they don’t see the disappointment on the faces of students when a new experience is presented and not everyone remains on the same page.”

Another teacher stated: “That ideal [of heterogeneous grouping], is an ideal….Truth is, in our experience the low-end kids tend to pull down the high-end kids, rather than the other way around. The class pace slows, and the teacher has to in effect devise two lesson plans for each period, one for the accelerated students and another for those who have low skills.”

In the past decade, many teachers have moved toward creating homogenous groups for reading and math within their heterogeneous classroom. One teacher who has 17 years of experience teaching in New Hampshire said that the second graders in her class showed up on the first day with a bewildering mix of strengths and weaknesses. Some children coasted through math worksheets in a few minutes, she said; others struggled to finish half a page. The swifter students, bored, would make mischief, while the slowest students would become frustrated, give up, and act out.

“My instruction aimed at the middle of my class, and was leaving out approximately two-thirds of my learners,” said this fourth grade teacher at Woodman Park Elementary in Dover, N.H. “I didn’t like those odds.”

So she completely reorganized her classroom. About a decade ago, instead of teaching all her students as one group, she began ability grouping, teaching all groups the same material but tailoring activities and assignments to each group. “I just knew that for me to have any sanity at the end of the day, I could just make these changes,” she said.

Flexible ability grouping, when used appropriately, works. According to a 2010 meta-analysis by Kelly Puzio and Glenn Colby, students who were grouped by ability within a class for reading were able to make up to an additional “half of a year’s growth in reading in one year.” Similarly, a 2013 National Bureau of Economic Research study of students who were grouped by ability found that the performance of both high- and low-performing students significantly improved in math and reading, demonstrating the universal utility of this tool, particularly as our classrooms become more academically diverse.

In summary, I believe that teachers have a more difficult time today than ever before. Their classes are getting bigger, their budgets are smaller, and heterogeneous grouping for the class means that effective teaching requires splitting the class into homogenous groups that each require a different lesson plan. Teaching parts of a class separately leads to less quality time that a teacher can spend with each group. Without essential one-on-one instruction time, students suffer. If the class isn’t divided into 2 or 3 homogenous groups for lessons the students suffer even more, as they are denied level-appropriate learning.

The current system discriminates against the lower two-thirds of society

What I find surprising is that more people don’t realize that the practice of heterogeneous grouping is actually discriminatory to the lower two-thirds of society. Wealthier families typically live in neighborhoods with better school systems (with students that are more homogenous in skill levels); can readily afford tutors for their children; can provide after school access to learning centers; give their children prep courses for various subjects and for SATs; and if all else fails, send their offspring to a private school. Those in the lower two-thirds, economically speaking, have more limited access to additional help outside the classroom, cannot afford private school, often have parents without college education who are less able to help them, and may not even take an SAT prep course. Each of these put them at a disadvantage versus those that come from the upper economic strata of America.

I myself had hardworking parents who had not gone to college. My father was an immigrant and had to work before completing high school. But my education was accelerated because homogenous grouping was the norm at that time. This included being placed into a class of high performers who all received 3 years of curriculum in two years and therefore skipped a grade. I also was able to take a competitive test that enabled me to be accepted into Stuyvesant, one of the very high-end public high schools in New York City, geared toward helping public school students receive an honors course level education. I firmly believe that the access I had to be paired with students that were high achievers played a very important role in my subsequent success.

Technology provides a range of alternatives

One potential way to bridge the gap is by having multiple teachers in a classroom but I think this would be extremely unlikely to be funded out of constrained government resources. A second possibility is to provide teachers with the training and technical resources that could be used to enhance the student experience. All too often when technology is utilized, it is not integrated into curriculum and/or very complicated to use. However, in recent years, there have been advances in K-12 education through the use of technology that is relatively easy to use and integrate to curriculum. For example, an Azure portfolio company, Education.com has created online workbooks and games that are aligned to the Common Core and are sold to parents and teachers for a starting price of $49 per year, making a subscription affordable to everyone. Millions of teachers and parents in the K-5 levels now are basic members of the site, which offers weekly emails and limited educational resources that can be consumed free each month. With a Pro subscription, a teacher can print out unlimited workbooks, worksheets, and lesson plans for their class. The company estimates that roughly one billion worksheets are printed each year by parents and teachers for students to use. While teachers are likely to print worksheets that complement their current curriculum, parents can use printable worksheets and workbooks as supplemental material to help their kids in academic areas where their skills need strengthening. The fact that about 8 million parents and teachers come to the site in a peak month also indicates how strong the need is for these types of materials.

Education.com’s Brainzy program is a first step at individualized learning. It uses games to practice strategies for mastering core curriculum for students in kindergarten through 2^nd grade. I have also met with a number of other companies who are creating products that can provide students with personalized learning tools. What Education.com and others are doing is still early steps in a process that I believe will lead to individualized education. If the United States keeps insisting on heterogeneous classroom composition but couples this with under-investing in education and requiring teachers to divide their time into separate lesson levels, then computer tools for the individual personalized instruction of each student appears to be the solution that can bridge the gap.

SOUNDBYTES

Stephen Curry picked up right where he left off last year scoring 40 points in the first game of the new season on strong shooting. Over the last 11 games, the Warriors remain undefeated behind Curry’s league leading scoring. After 11 games, Curry is averaging 33.4 points per game, a full 5 points ahead of the number two, James Harden, at 28.4 points per game. On Saturday night, in Curry’s 427^th game, he surpassed the number of threes made by his father, Dell Curry, over his 1,083 game career. Earlier this year, we discussed why Curry deserved to be the clear NBA MVP and analyzed his scoring efficiency adjusting for his ability to hit threes from seemingly anywhere on the court (he was subsequently voted the MVP) .

Curry backup

Curry’s shooting has been even more dominant this year. Even based on “standard” statistics, Curry leads the pack not only in scoring average but also in field goal percentage. At 51.7% he trails only Blake Griffin, who has only taken 3 three-point attempts this season, in the top 10 scorers. Looking at “Field Goal Efficiency” (FGE%), a metric introduced in our previous post, that calculates a 3-point field goal as worth 1.5 times a 2-point field goal, we see Curry’s true dominance this season. Also, “True Shooting Percentage” (TS%) assumes that 1 of every 9 foul shots is part of a 3-point (or 4-point) play and therefore considers 2.25 foul shots as the same as one field goal attempt (since most pairs of foul shots replace a field goal attempt). Looking at these metrics we continue to see Curry’s clear dominance. Curry’s performance is off the charts as he is nearly 7 percentage points ahead of the second highest of the top ten scorers in FGE% and he is also well ahead of anyone else in TS%.
In a recent ESPN segment, Brad Daugherty called Curry “un-defendable”. If he continues to shoot the ball at this level, the road to a second consecutive championship and another MVP seems well paved.

[1] Organization for Economic Cooperation and Development (OECD), Program for International Student Assessment (PISA). 65 educational systems ranked.

[2] Pearson Global Index of Cognitive Skills and Educational Attainment compares the performance of 39 countries and one region (Hong Kong) on two categories of education: Cognitive Skills and Educational Attainment. The Index provides a snapshot of the relative performance of countries based on their education outputs.

[3] International Study Center at Boston College. Fourth graders in 57 countries or education systems took the math and science tests, while 56 countries or education systems administered the tests to eighth graders.

The Argument for Curry as a Unicorn

April 15, 2015April 15, 2015 Mike Kwatinetz Golden State Warriors, NBA, Sports, Unicorns, Valuation Golden State Warriors, NBA, Stephen Curry, Unicorns

In our previous post we posed the potential for Stephen Curry to become a Unicorn (in venture this is a company that reaches $1 billion in value). While it was mostly for fun, on reflection we decided that it actually could prove valid. This post will walk you through why an athlete like Curry (or potentially James Harden, Russell Westbrook or Anthony Davis) could become a Unicorn should they be elevated to the elite status of a LeBron James.

The Precedent for Creating a Corporation Owning an Athlete’s Earnings Exists

In April 2014, Vernon Davis offered stock in his future earnings via a venture with Fantex, Inc. as part of a new financial instrument being sold by Fantex. Davis offered a 10% share of all future earnings from his brand marketing company to Fantex, which would then turn around and divide it into shares of a tracking stock that can be traded within their own exchange. The offering was 421,100 shares, valued at $10 each, for a total of $4.2 million. This implied a total value of the “Vernon Davis Corporation” of $42 million. Davis’ current salary is $4.7 million and endorsement income about $1.75 million for a total income of $6.5 million. Given that the longevity of football players is rarely into their mid-thirties coupled with Davis being over 30 at the time, it seems likely that he had no more than 3-4 years left in his playing career. Putting those facts together makes it appear that Davis was unlikely to earn much more than $42 million going forward and might earn less as we would expect his income to drop precipitously once he retired. So buying the stock was probably viewed as more of a symbol of support for Davis and its “market cap” appears about equal to his expected future earnings.

NBA Stars are Among the Highest Earning Athletes’

The current highest earner of endorsements in the NBA is LeBron James at about $44 million per year (Kevin Durant is second at $35 million). The highest contract in the league is Kobe Bryant at about $23 million per year (and had been $30 million previously) with the 10 highest players in the league making an average of over $21 million. Given the new TV contract scheduled to go into effect in the 2016-2017 season, it’s been projected that the cap will increase from about $63 million today to $90 million in 2017 and be nearly $140 million by 2025 (10 years from now, at age 37, Curry should still be playing). Let’s make the following assumptions:

Curry’s salary will go from a current level of $11 million in 2015 and 12 million in 2016 (4 other Warriors will be paid more that year) to about $30 million in 2017 assuming the top salaries tend to be about 1/3 of their team’s cap as they are today.
It will be up to $40 million in 2025, or less than 1/3 the projected $140 million cap.
His endorsements will reach midway between the current levels experienced by LeBron and Durant, to about $40 million by 2017 (they are currently at about $5.5 million from Under Armour)
His endorsement income will rise by about 10%/year subsequently, through 2025 to reach $92 million in 2025
He will continue to earn endorsement income (but will retire from playing) subsequent to the 2025 season.
The level post 2025 will average $60 million per year for 10 years and then go to zero.

The last assumption is based on observing the income of retired stars like Michael Jordan (earning $100 million/year 12 years after retirement), David Beckham (earned about $75 million the first year after retiring), Arnold Palmer (earned $42 million/year 40 years after winning his last tournament), Shaq ($21 million), Magic Johnson is now worth over $500 million. Each are making more now than the total they made while playing and, in several cases, more per year than in their entire playing careers. So assuming Curry’s income will drop by 1/3 after retirement is consistent with these top earners.

This puts his total income from 2016 through the end of 2035 at over $1.5 billion. All of the above assumptions can prove true if Curry continues to ascend to super-star status, which would be helped if the Warriors win the championship this year. They could even prove low if Curry played longer and/or remained an icon for longer than 10 years after retiring. Thankfully, Curry has remained relatively injury free and our analysis assumes that he remains healthy. Curry is not only one of the most exciting players to watch, but is also becoming the most popular player with fans around the league. Curry now ranks second overall in total uniform sales, behind LeBron James.

So while the concept of Stephen Curry as a Unicorn (reaching $1 billion in value) started as a fun one to contemplate with our last post, further analysis reveals that it is actually possible that Fantex or some other entity could create a tracking stock that might reach that type of valuation.

As a VC, I would love to invest in him!

SoundBytes:

In the recent game against the Blazers there was further validation of Curry’s MVP bid. Curry delivered eight 3-pointers, hit 17 of 23 shots and went 7-of-7 in his 19-point fourth quarter. His last two threes were a combined distance of 55 feet, setting a new record for threes in a season and breaking his own record!
To understand just how well Curry shot, his Field Goal Efficiency was 91% (he had 8 threes bringing his equivalent field goals to 21/23). Not only was this higher than anyone who scored 40 points this year or took at least 20 shots in a game, we believe it may be among the highest ever for someone taking 20 shots in a game.
As a comparison, the two Portland stars, Aldredge and Lillian, each had strong games and scored 27 and 20 points, respectively. But, to do that, they took 46 shots between them (double that of Curry) and only scored 2 more points in total for the extra 23 shots!
The 4^th quarter performance by Curry, cited above, translates to a 114% FGE rating, which is averaging more than 100% shooting as he scored 16 points on 7 shots. When foul shots are taken into account, his True Shooting % was 137% as he scored 19 points on 8 field goal attempts (counting the one on which he was fouled).To draw a comparison, when Russell Westbrook scored 54 points against Portland on April 12 he took 43 shots, 20 more than Curry (23 more if we include shots that led to foul shots).

Is Stephen Curry Becoming a Unicorn?

April 9, 2015April 15, 2015 Dan Park Golden State Warriors, NBA, Sports, Unicorns Golden State Warriors, NBA, Stephen Curry, Unicorns

Why Curry should be the clear NBA MVP

Much has been written about the importance of discovering and investing early in “Unicorns”, companies that eventually cross the $1 billion valuation threshold. In basketball, teams make tough decisions as to whether to sign individual players to contracts that can be worth as much as $120 million or more over six years. The top few players can earn a billion dollars over their career when endorsements are added to the equation, assuming they can last as long as a Kobe Bryant or Tim Duncan. Clearly part of the road to riches is getting the recognition as one of the elite. This year, several players previously thought of as “quite good” are emerging in the quest to be thought of as “great”. Nothing can help a player put his stamp on such a claim as much as winning the MVP. In the spirit of trying to identify a future “Unicorn” in professional basketball, I thought it would be fun to analyze the current crop of contenders.

Given an unusual emergence of multiple stars, this year’s NBA MVP race is one of the most hotly contested in years. There are five legitimate candidates: Stephen Curry, Russell Westbrook, James Harden, Anthony Davis and LeBron James. All of them are having spectacular seasons and in most years that would be good enough for them to win. But only one can take the MVP crown. LeBron is the reigning king of the league and has long ago hoisted his flag atop the mountain. But, he has won the MVP title a number of times and while he remains a solid choice, he is not a clear choice. Therefore, it appears almost certain that most voters will favor a candidate who has yet to win. In the last few weeks Davis seems to have faded from consideration so, in this post, I will provide the analysis that has led me to determine that Curry is a more worthy recipient than Westbrook and Harden.

Scoring

Basketball columnists and analysts often focus too much of their evaluation of success on a player’s scoring average. In an attempt to help understand a player’s full value, John Hollinger created a Player Efficiency Rating (PER) that incorporates several statistics in the hope it provides a single rating that determines the best player. While it is a truly worthy effort, we feel there is quite a bit of judgement incorporated in what value to place on different statistics. For example, it rewards players who take more shots even when the extra shots are 2-pointers at a low field goal percentage (taking extra 2-point shots at over a 31% increases the rating even though that is well below what the rest of his team would likely shoot). We would place more value on giving the ball up (and having a lower scoring average) than taking a low percentage shot.

I am surprised that the simplest calculation of scoring efficiency does not surface as a regularly reported statistic. Some sources occasionally report an “Adjusted Field Goal Percentage” (AFG%) that counts a 3-point field goal as worth 1.5 times a 2-point field goal. We believe this is the correct way of viewing a shooter’s effectiveness and called it field goal efficiency (FGE%). It calculates the percentage as the equivalent of 2-point field goals made per field goal attempt (FGA):

FGE% = (2-point shots made + 1.5 x 3-point shots made)/FGA

There is one statistic that analysts call True Shooting Percentage (TS%) that goes one step further. It also takes foul shots into account. It assumes that 1 of every 9 foul shots is part of a 3-point (or 4-point) play and therefore considers 2.25 foul shots as the same as one field goal attempt (since most pairs of foul shots replace a field goal attempt). TS% is calculated by adding the field goal attempt equivalent of foul shots to normal field goal attempts to determine the equivalent number of attempts used by a player. By dividing points scored by 2 we know how points scored equates to 2-point field goals made (FGME). This translated to the following formula for TS%:

Equivalent field goal attempts (EFGA) = FGA + FTA/2.25

FGME = points scored/2

TS% =FGME/EFGA

Now let’s compare Curry, Harden and Westbrook based on these statistics all on a per game basis:

Harden and Westbrook are neck-and-neck in scoring average, each about four points per game higher than Curry. But Curry plays fewer minutes per game and takes fewer shots. His shooting efficiency at 58.6% is by far the highest of the three by a significant amount (a full 14% higher than Westbrook and 7% higher than Harden). It is also the highest in the league for players that have taken at least 8 shots per game (which includes all of the top 100 players by scoring average). At over 90%, Curry is the number one foul shooter in the league. But Harden and Westbrook are also hitting roughly 85% of their foul shots. Therefore, the fact that they get fouled much more than Curry brings each of their TS%s closer to Curry’s. Still, Curry is a whopping 10% higher than Westbrook and 2.5% higher than Harden. It is apparent that the scoring average advantage is more a function of Curry playing fewer minutes and being more selective in his shots.

To see the impact of this we calculated their scoring average per 36 minutes played (which we consider about average for a team’s star) and points scored per 25 equivalent field goals attempts:

So, even if he played the same amount of time as Harden and Westbrook, Curry would trail in average points per game, primarily because he still would take fewer shots. But if he took the same number of equivalent shots he’d have a higher scoring average than both.

A Few Other Statistical Comparisons

While scoring efficiency is an important measure of a players value to his team, several other statistics like assists, rebounds, and steals are also considered quite relevant. To make comparisons fair, we adjusted to the average per 36 minutes for each:

For steals, Westbrook and Curry are close to dead even with Harden about 11% behind. However, Westbrook is the clear leader in rebounds and has 7% more assists than Curry with both well ahead of Harden.

Each of these three players leads their team’s offense. They all control the ball attempting to score themselves or assist others in scoring without turning the ball over, as every turnover is a lost scoring opportunity. The ratio of assists to turnovers helps capture effectiveness as a guard. On the defensive end they each can compensate for a portion of their turnovers by stealing the ball. The ratio of steals to turnovers captures how well they are able defensively to partly compensate for depriving their team of a scoring opportunity. But attempts to steal the ball can lead to more personal fouls. The ratio of steals to personal fouls helps understand defensive effectiveness. Here are the comparisons:

Harden and Westbrook are 25%-40% behind Curry in all of these categories. What the first ratio tells us is that Curry passes the ball more accurately and/or takes less risk so that he gets his assists without turning the ball over as frequently as the others. Another way of looking at it is that the extra 0.6 assists that Westbrook averages per 36 minutes comes at the expense of one extra turnover vs Curry. The steal/turnover ratio tells us that for every 3 turnovers Curry has, he is able to get the ball back twice through steals. The others recover less than half of their turnovers through steals. Finally the steals/personal foul ratio shows that Curry is quite effective defensively with a ratio that is over 30% better than either of the others.

Curry Creates the Most Team Success

So, what is the bottom line that helps capture the impact of the various statistics we have shown? Of course one measure is the fact that Curry has helped his team achieve a much better record. What other measure should be considered in evaluating a potential MVP’s impact on a team? Given Curry’s extremely high Field Goal Effectiveness, does his taking fewer shots help the team more than Harden and Westbrook taking more shots and scoring more? The league average for scoring per game is roughly 99.9 points (through about 76 games of the season). Each of the three help their team score at a higher rate than that, but Curry has led the Warriors to the highest scoring per game in the league. The comparison:

A natural question is whether this superior offensive performance comes at the expense of inferior defense. So we should include the average points given up per game by each team to round out the picture. Notice the Warriors allow fewer points per game than the league average while both the Thunder and the Rockets allow more than the league average. The combination for the Warriors means that they have the highest plus/minus in the league by quite a bit (the Warrior’s 10.4 is 60% higher than the Clippers who are second at 6.5), and it is nearly double the sum of the plus/minus for the Rockets and Thunder combined.

The league also maintains plus/minus differential by player. That is how many more points a team scores than opponents when that player is on the floor. In all three cases, it seems clear the players are driving the team’s effectiveness as their differential exceeds that of the teams (meaning that without them on the floor, the other team, on average, outscores their team). This statistic takes offense and defense into account and helps measure the influence a player has on his team’s effectiveness.

This means that Curry is responsible for a 12.0-point improvement in plus/minus when on the floor versus how the team does when he isn’t, while both Westbrook and Harden improve their team’s plus/minus by 5.0 points. Given his top score in plus/minus, much higher Field Goal Effectiveness and TS%, combined with driving the Warriors to the top record in the league, it seems that Curry should be the league MVP and is on his way to becoming a Unicorn. As a VC, I would love to invest in him!

SoundBytes:

The recent ESPN selection of the top 20 players of the past 20 years is quite enlightening in how well the NBA markets their elite players compared to other sports. Despite the fact that football and baseball have a multiple of the number of players and are more popular sports, five of the 20 were from the NBA:
- Number 1: Michael Jordon
- Number 2: LeBron James
- Number 8: Kobe Bryant
- Number 11: Shaquille O’Neal
- Number 14: Tim Duncan
There were 3 from football (all quarterbacks) and 2 each from baseball, tennis and soccer. And one each from 6 other sports (hockey, boxing, golf, swimming, track and cycling).
The four emerging stars (this includes Anthony Davis) we have discussed all have the potential to be on a future such list but their status among the greatest will also be dependent on their ability to win multiple championships. Winning MVPs makes a player great, winning multiple championships makes them one of the greatest.
Last night’s game against the Blazers was further validation’s of Curry’s MVP bid. Curry delivered eight 3-pointers, hit 17 of 23 shots and went 7-of-7 in his 19-point fourth quarter. His last two threes were a combined distance of 55 feet, setting a new record for threes in season and breaking his own record!

2021 Stock Recommendations:

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

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

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

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

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

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

Non-Stock Picks for 2021

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

8. Real Estate will Show Surprising Resiliency 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

10. The Warriors will make the playoffs this Year

SoundBytes

Bull Markets have Tended to Favor My Stock Picks

2020 Non-Stock Top Ten Predictions also Impacted by Covid

The 2020 Stocks Picked to Outperform the Market (S&P 500)

1. Tesla stock appreciation will continue to outperform the market (it closed last year at $418/share). Note that after the 5 for 1 split this adjusts to $84.50/share.

2. Facebook Stock will outpace the market (it closed 2019 at $205 per share)

3. DocuSign stock appreciation will continue to outperform the market (it closed 2019 at $74/share)

4. Stitch Fix stock appreciation will continue to outperform the market (it closed 2019 at $25.66/share)

5. Amazon stock strategy will outpace the market (it closed last year at $1848/share)

6. I added Zoom Media to the list of recommended stocks. It closed 2019 at $72.20

Unusual Year for the Non-Stock Predictions

7. The major election year will cause a substantial increase in advertising dollars spent

8. Automation of Retail will continue to gain momentum

9. The Warriors will come back strong in the 2020/2021 season

10. At least one of the major Unicorns will be acquired by a larger player

2021 Predictions coming soon

Soundbytes

2020 Stock Recommendations:

1. Tesla stock appreciation will continue to outperform the market (it closed last year at $418/share)

2. Facebook stock appreciation will continue to outperform the market (it closed last year at $205/share)

3. DocuSign stock appreciation will continue to outperform the market (it closed last year at $74/share)

4. Stitch Fix Stock appreciation will continue to outperform the market (it closed last year at $25.66/share)

5. Amazon stock strategy will outpace the market (it closed last year at $1848/share).

6. I’m adding Zoom Video Communications to the list but with an even more complex investment strategy (the stock is currently at $72.20)

Outside of my stock picks, I always like to make a few non-stock predictions for the year ahead.

7. The major election year will cause a substantial increase in advertising dollars spent

8. Automation of Retail will continue to gain momentum

9. The Warriors will come back strong in the 2020/21 season

10. At least one of the major Unicorns will be acquired by a larger player

1. Increase Follow-On sales from existing customers

Hi there,

My name is Katie, and I’m a member of the Harry’s team. I wanted to reach out and say thanks for supporting Harry’s.

All the best, Katie

2. Raise the average invoice value of the initial and subsequent sales to a customer

3. Increase Gross Margin through price Increases

4. Improving GM by reducing COGs

5. Improving CM by driving “free” or “nearly free” traffic

6. Decrease Marketing Spend as a % of Revenue.

SoundBytes

Deeper analysis on what constitutes MVP Value

Controlling the buying experience

Receiving the product

Summary

SoundBytes

Why the quality of education in the United States trails

Classroom sizes have been increasing

Heterogeneous grouping exasperates the problem

The current system discriminates against the lower two-thirds of society

Technology provides a range of alternatives

SOUNDBYTES

[1] Organization for Economic Cooperation and Development (OECD), Program for International Student Assessment (PISA). 65 educational systems ranked.

[3] International Study Center at Boston College. Fourth graders in 57 countries or education systems took the math and science tests, while 56 countries or education systems administered the tests to eighth graders.

All the best,
Katie