Predictions

Top Ten List for 2024

Mike Kwatinetz Predictions, Stocks, Technology ,

Last year was a very strong one for our top ten picks where all 10 proved correct, and our six recommended stocks were up an average of 96% with 3 of the 6 appreciating over 100%. While there is some risk in continuing to recommend them after such a strong surge last year, we believe they will perform well this year and already said (in the previous post) that each would be on the new list. The price per share we’ll use is as of December 31, 2023, for each (including Tesla which is down about 25% YTD). We are going to add one new stock to the group, Nvidia, which is a strong play on the push to AI as its chips are well ahead of others for that space.

The first 6 declined substantially in 2022 despite solid performance as they were victims of interest rates surging. The Fed has indicated that rates will likely decline in each of the next few years which should, in turn, help our “long-duration” stocks appreciate. The risk to this assumption is if inflation reverses its downward trend and surges once again. That could mean the Fed not only reverses its projection of declining rates but might increase rates once again. This would be quite negative for our stocks as there is a built-in assumption in the market that this will not occur.

Even with the 96% average gain in 2023, in the past 2 years the average of the 6 (we’ll talk about Nvidia separately) is still down 18.6% despite average revenue expanding by 86% in the same period. What this means is the price/share to revenue has declined by 56% in the past 2 years. If we looked at this over 3 years the decline would be even steeper. So, even if one believes that these stocks were at an inflated price at the end of 2021, they do not appear to be inflated now. Given that they are all growth companies (with analyst estimates showing 5 of these 6 growing 20% or more in 2024 and the 6th, Amazon, growing over 11%) it appears to us there is still strong upside barring extraneous events that cause difficult market conditions.

Of course, there is another issue for bears to jump on – the potential for a recession. This could undermine company performance. It appears we are headed for a “soft landing” but that still is not a given, especially if rates don’t start coming down at some point in 2024.

I’ve often pointed out 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 Rates decline, etc. Given the compression in revenue multiples across the board in tech stocks over the past three years (the three year decline was even greater than shown in our above two year table), the opportunity for investing still appears timely to me despite last year’s appreciation in the stocks.

2023 Stock Recommendations (Note: base prices are as of December 31, 2023)

1. Tesla will continue to outperform the market (it closed at $248.48/share)

While Tesla did appreciate over 100% in 2023, its stock still was nearly 30% lower than on December 31, 2021. This occurred even though revenue was up almost 70% in the same two-year period. And the stock is down over 25% YTD in 2024. While the company reached its target  of over 1.8 million vehicles sold in 2023, it came at a cost of much lower gross margins leading to a very low growth rate for revenue in Q4 and disappointing earnings.

This plus several other issues have weighed on the stock:

  1. The Cybertruck, which has a massive backlog, is expensive to manufacture and could have very low gross margins until it ramps up to volume which is not expected until late this year. In 2025 it should add a more substantial number of units to Tesla sales.
  2. Elon keeps causing concern amongst investors with his behavior.
  3. The growth in sales of BEVs (Battery Electric Vehicles which does not include Hybrids) seems to be slowing. We always expect high growth rates to decline over time but still believe sales of BEVs will grow over 20% per year for some time. See our blog post for a full analysis of why we expect BEV sales to grow at a high rate for the next 5 years.
  4. The strategy of lowering prices to drive share gain is working in terms of market share gains but has had a negative impact on revenue growth and profitability.
  5. Competition is getting stronger.

While we agree that the Cybertruck will likely take much of 2024 to ramp up production it’s important to realize that sales of this vehicle are incremental for growth so selling 90,000 units would add 5% to Tesla’s 2024 unit growth rate (and more to its revenue growth rate), 180,000 would add 10%. We’re guessing shipments will likely be between the two with more than half in Q4. The vehicle is so unique that it should also act as a draw for people to visit Tesla showrooms which will help sales of other models.

If Elon is a bit distracted that should not impact Tesla as its product road map is pretty well set for the next 3-5 years. If his comments cause a subset of people to decide not to buy a Tesla this may be offset by others liking them and considering the vehicle.

High growth rates almost always decline over time as a product scales. The growth in sales of BEVs cannot stay at the level it’s been at so it shouldn’t be a surprise that it is slowing. In 2022 BEV unit growth was about 60%, down from over 100% the year before. In 2023 it appears to be about 37%, still a very attractive rate. Because of high interest rates 2024 auto sales growth will moderate across all vehicle categories but we expect it to reaccelerate as rates decline.

The competition from Chinese manufacturers is getting stronger. But competition appears to be weakening from everyone else. In November General Motors announced a lowering of its sales and production goals. This month Ford announced a large reduction in investment in Electronic vehicles. In September Volkswagen cancelled its plans for a new factory for building BEVs. To us this means Tesla and one or two Chinese manufacturers are out executing traditional auto companies and gaining share. As more customers convert to BEVs we believe Tesla will continue to gain share of the overall market.

Analysts are predicting that Tesla will grow revenue by 15% -20% in 2024. We believe it could be higher given the introduction of the Cybertruck, expansion of sales of the Semi, and unit growth that we expect to be 25% or more. Revenue growth will be slowed by lower pricing vs the prior year in the first 2 quarters but helped by the ramp of the Cybertruck in the second half of the year. By Q3 Cybertruck sales will be more meaningful and the ASPs of other Tesla models vs Q3 2023 will be better. All in all, we expect Tesla to return to over 25% revenue growth by Q4 and potentially grow over 20% for the year as a whole. We believe this not only means that its stock will make up the ground it has lost YTD but could show solid appreciation over the close on December 31, 2023.

2. Shopify will outperform the market (it closed at $77.88 per share)

In our post of Top Ten predictions last year, we pointed out that the pandemic had created a major warping of Shop revenue growth.  Instead of the normal decline for high growth companies from its 47% level in 2019 it jumped to 86% growth in 2020 and still was above “normal” at 57% in 2021. Once physical retail normalized in 2022, Shopify growth plunged against the elevated comps declining to a nadir of 16% in Q2, 2022. When we included Shop in our Top Ten for 2023, we pointed out that we expected its revenue growth to return to 20% or more throughout 2023. This indeed did occur, and Shopify revenue growth was about 25% for the year. We expect the 20% – 30% growth rate to continue in 2024 as:

  1. Net revenue retention for the company continues to be over 100% due to Shopify successfully expanding the 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. 
  2. Shopify has emerged as the number one alternative to Amazon and larger companies are now being added to its customer base.

We believe Shopify remains an undervalued stock as its price to revenue is still 63% lower than at the end of 2021.  Additionally, the company is now at the point of leverage where earnings should grow faster than revenue.

3. CrowdStrike will outperform the market (it closed at $255.17 per share)

CrowdStrike (CRWD) has now rebranded itself as the “AI Native Security Platform”  given its leadership in using AI to prevent breaches. The company continues to gain a substantial share of the data security market. Given its leadership position in the newest technology coupled with what is still just over 3% of its TAM, CRWD remains poised for continued high growth. This coupled with over 120% net revenue retention for 20 straight quarters makes CrowdStrike a likely long-term grower at over 30% per year. High revenue retention is primarily driven by expanded module purchases where 63% of subscription customers now pay for 5 or more modules.

The recent threats by Russia to create a Cyber attack on the U.S. could be an additional boost to the entire security industry. CrowdStrike stands to be a disproportionate beneficiary as it has the most advanced technology for defending companies against such attacks.

4. Amazon will outperform the market (it closed at $151.75 per share)

As we forecast, Amazon improved revenue growth in each quarter of 2023 from its low point of 8.6% in Q4 2022. In Q3 2023 growth was back to 12.6%.  Additionally, the company increased its focus on profitability with Q3 profits up well over 200% versus the prior year’s weak numbers. This coupled with the improved environment for tech stocks helped drive Amazon’s share price to $151.75 at year end, up 81% from the close on December 31, 2022. We expect revenue growth to exceed 12% in 2024.

While continuing double digit revenue growth will help, a second potential driver is that new CEO Jassy seems to have decided to increase the focus on earnings growth. This is available to Amazon if it chooses to do so. If he continues that trend, it could be a catalyst to share appreciation. For example, Prime remains a distinct bargain as it not only includes free shipping but also a number of other benefits such as video streaming of movies and TV shows, some free eBooks, discounts at Whole Foods and more. Given that Prime has over 220 million members, a $20/year increase for the subscription or additional monetization of content in that amount per user (which equates to less than one extra movie or TV series purchased every 4 months) would add over $4.4 billion to revenue once it fully rolls out. Such an increase is worth about $8 per share of earnings. Additionally, the company has meaningful AI technology that could drive additional revenue. Amazon has also been trimming costs (as a percentage of revenue). Given this combination, we expect earnings to grow faster than revenue in 2024.

5. Data Dog will outperform the market (it closed at $121.65 per share)

Like many other high growth subscription-based software companies, Datadog experienced another solid year in 2023 with Q3 revenue growth at 26.7%. Also, like CrowdStrike, Datadog has a very high gross margin (GM) and is now at the point where it has started to leverage its GM driving up earnings (+96%) at a much faster rate than revenue. While the stock was up 66% in 2023, it is still down 32% over 2 years despite Q3 2023 revenue being 195% higher than Q3 2021.

6. The Trade desk (TTD) will outperform the market (it closed at $71.80 per share)

Every 4 years we point out that political spending in a Presidential election year adds an additional layer of revenue to the advertising space helping it have an above normal year of growth. In 2024 there are 3 additional factors that should help drive accelerated growth (discussed in prediction 9). CTV (Connected TV) has been gaining share of the space and The Trade Desk remains a leader in CTV. Analysts are forecasting 20% revenue growth for the company in 2024. We believe an increased market size coupled with share gains should help TTD grow revenue at an even greater rate. We believe such a result will lead to another year of solid stock performance.

7. Nvidia will outperform the market (it closed at 495.22 per share on December 31, 2023)

Nvidia is one of the strongest ways to invest in the coming AI evolution. Its generative AI-optimized GPUs have a technology lead on its competition and are needed by companies moving to AI. The demand for such a product currently exceeds supply, giving the company several quarters of backlog. Because of the shortage supply coupled with a superior product Nvidia has significant pricing power. 

In Q3 the company’s revenue grew over 200%. Because its gross margin was up to 75% the combination drove earnings of $4.02 for the quarter up nearly 7X from the prior year’s $0.58. Based on current earnings forecasts the stock is not expensive, trading at about 30X analyst earnings forecast for fiscal 2025 (year ending in January 2025).

Make no mistake, this will be a volatile stock given its startling growth. The question of whether current pricing can be maintained as stronger competition emerges could be an overhang. AMD launched a competitive product in December. It expects to ship as much as 400,000 GPUs in 2024. But, to put it in perspective relative to demand, Nvidia is forecasting shipping 1.5-2.0 million GPUs this year up from about 550,000 in 2023. This would mean AMD is projecting unit sales of about 25% of Nvidia units in 2024. It seems unlikely that AMD will try to force down pricing in 2024. Also, in general, the cost of manufacturing chips declines as a product matures so even if pricing declines 20%, gross margins could remain close to where they currently are. Intel is also working on becoming a leader in AI. It has several products and numerous customers but appears to be trailing Nvidia (and AMD) in technology.

A second potential issue for Nvidia is sales to China which comprised over 20% of its sales in Q3. The US government has restrictions on selling the most advanced technology to Chinese companies and Nvidia believes it has complied. The company also stated that it expects the percent of sales to China to decline in Q4.

For now, we believe Nvidia will continue its momentum throughout 2024 and beyond. Given that demand is growing rapidly (there are forecasts that 80% of all PC sales will be AI enabled in 4-5 years) pricing pressure that causes significant GM decline appears unlikely to emerge in the next 2-3 years. As we saw in the PC space (where Intel controlled things), as pricing on older chips declined, users tended to buy newer technology meaning that instead of paying less for the older product they paid what they had before for a more powerful product. It appears that the AI space is still young enough to replicate this trend.

8. Other “AI” Companies will emerge as strong performers.

Like the PC revolution in the 90s and the web from 2000 onward, AI appears to be a new generation for products that will lead to existing companies re-inventing themselves and new ones emerging. Each of the prior decades-long trends spawned numerous successes. It appears  that AI will be the next generational change in technology. It will dominate thoughts on Wall Street for the next decade or more with numerous winners emerging. While it’s hard for us to tell who else besides Nvidia, CrowdStrike and Tesla will distinguish itself as an AI leader and generate high revenue growth rates there are a number of candidates that are at the table.

In the chip world, AMD seems a strong candidate. Intel is trying to transform itself to another candidate but it has a large share of existing sales, so it needs to become a leader to generate enough new revenue to offset its loss of more traditional sales. IBM is inserting AI chips into its products which could mean a resurgence of demand for servers at higher pricing and margins. The same could be said for PC manufacturers.

While chips and hardware are the first stage of revenue generation from AI, hosting services from Microsoft, Amazon and others could be the next step in rolling out AI. They can potentially increase pricing and also grow their services. Social networks will also benefit but I’m not sure how someone like Meta can drive enough growth in monetization.

Security is already an important use of AI and CrowdStrike has utilized it to great effect. Others like SentenilOne are following in their footsteps. Gaming is another arena where AI will be important. And autos need to utilize it if autonomous self-driving cars are to become dominant. Tesla is at the forefront in creating such success with Waymo another very important player.

One of the most exciting arenas for AI is in robotics. Tesla is working on a robot that will heavily utilize AI to manage its movements, but a commercial product seems years away.

9. Furniture and Home accessories will stage a comeback in 2024, returning to growth.

Not surprisingly, home sales diminish when higher interest rates on mortgages increase the cost of ownership. And when this happens very quickly sellers are slow to reduce prices to reflect the inability of buyers to pay the same price as when rates were lower. The result last year was that US home sales hit a 30-year low. Additionally, homeowners taking out loans to remodel also stalled due to the higher rates. Sales of furniture and related accessories are highly correlated to home purchases and home remodels and were down 5-10% in 2023 vs 2022. Now that some time has passed where owners had difficulty selling their homes many are lowering prices making the cost of ownership more affordable. Also, The Fed is expected to stabilize and then reduce rates this year. This combination should lead to more home purchases and home remodels. Given the “easy comps” and built-up demand we expect furniture and related accessory sales to return to double digit growth during 2024 after a year of declining revenue.

10. Advertising revenue will have a comeback in 2024.

Advertising revenue was hurt last year by the economy as well as several short-term issues like the decline in furniture sales discussed in prediction 9. Many advertisers cut back spending due to issues with the economy. Stable interest rates should lead to increased spending by advertisers of goods and services.

Advertising also took a major hit from strikes in the auto industry and Hollywood. In each case this led to a loss of ad revenue. Without many new movies and shows media advertising was cut dramatically (no pun meant). And of course, GM, Stellantis (formally Fiat/Chrysler) and Ford cut their spending during the union strike.

Political spending on advertising mostly occurs in even years when the bulk of elections take place. Every fourth year this is boosted by the presidential primaries and election. Group M estimates that advertising spending (excluding about $1B spent on direct mail) will be about $16 billion dollars this year, up over 31% from the 2020 election year. While the bulk of the dollars will be spent on TV, online platforms like Facebook and Google will benefit as well. This also is likely to be the first presidential election where AI tools are used to improve targeting of potential campaign contributors.

EVs will dominate new car sales within 5-6 years

Mike Kwatinetz Cars, Predictions, Stocks, Technology ,

What does that mean for Tesla and others?

EVs include both BEVs (Battery Electric Vehicles) and PHEVs (Plug-In Hybrid Electric Vehicles). We’ll start with a top-down view and then go into substantial detail regarding Tesla followed by some overall discussion of Rivian and Lucid.

California is taking the lead in banning sales of new gas-powered cars by 2035.

In August 2021, President Biden issued an Executive Order setting a target that by 2030, 50% of all new vehicles sold in the US will be net zero emitters of greenhouse gasses. He has recently added a goal of 60% by 2032. California has drawn a line in the sand regarding legislating the end of gas-powered vehicles. A measure approved by the California Air Resources Board requires all new light vehicles (passenger cars, SUVs and pick-up trucks) sold in the state in 2035 or later to generate zero emissions. It is a little unclear whether this will allow PHEVs to be sold, as they do generate emissions, but my reading suggests that PHEV models that can be charged at a charging station are probably not currently part of the ban. I expect this to change and believe PHEVs will be banned as well or fall to minimum sales once the conditions for BEVs described below are met. Six other states have already followed California’s lead: Maryland, Massachusetts, New Jersey, New York, Oregon, and Washington. Numerous other states are in the process of considering moving in the same or an even more aggressive direction.

I believe that most of the country and the rest of the world will follow in this direction (unless lobbying efforts slow progress) as the following issues are already or likely to be met by 2030:

  1. BEVs must offer enough driving range to make buyers comfortable;
  2. BEVs with the right characteristics need to become more affordable;
  3. There must be close to the same access to charging stations as gas cars have to gas stations.

Driving Range on dozens of BEVs will likely exceed 500 miles by 2030.

For perspective consider that (according to Electrek) in 2012 there were only 9 EVs available, 8 of which were Hybrids that, on average, could only drive about 70 miles on the battery. The 9th was the Tesla Model S which had a range of 265 miles but cost about $90,000. As late as 2016, there was still only one pure BEV with a driving range of over 300 miles, the Tesla Model S. By 2021, this number had expanded to 5, 3 of which were Tesla models. As of August 2023, there are 14 models with that range including 4 from Tesla, 2 from Rivian and one from Lucid. Lucid has the longest range, 520 miles, but the two Rivians and the Tesla Model S Long Range all are over 400 miles. The list includes 2 models from Ford, two from BMW, plus one each from Mercedes, Kia and Hyundai. What this suggests is that further increases in driving range are not only possible but extremely likely (in fact preliminary reports indicate the next version of the Tesla Model 3 due in 2024 will move to over 400 miles of driving range). I believe that in 7 years, or even sooner, there will be numerous models that have a range of over 500 miles, including all Tesla models, all Rivians and all Lucids. This is a technology issue and as we’ve seen with computers and phones, technology delivers better performance every year.

Affordability is already here…sort of!

The standard Model 3 is listed on Tesla’s website as having a manufacturers suggested retail price of $32,740 after the federal EV tax credit. But California also provides a state tax credit of $7500. After that credit the price drops to $25,240, $1,000 less than a gas-powered Toyota Camry. That doesn’t even consider the lower cost of service and fuel, or the higher resale value of the Tesla. This has led to the Model 3 replacing the Camry as the best-selling car in California, This depends on tax credits so we’re not quite at parity yet on affordability but given the trend we should be in several years.

Charging availability is increasing rapidly.

According to the Department of Energy, the number of charging stations in the US increased from 5,070 in 2011 to 143,711 at the end of 2022. This represents a compound annual growth rate of about 35.5%. The stations have also improved in their speed to charge. It is also easy to install a power line at home to be able to charge the vehicle every night, eliminating the need to use a charging station other than for long trips. Gas powered cars do not offer this convenience. For example, my wife and I recently went from our home in Atherton to Napa for a weekend, a distance of about 90 miles each way. In total, including visiting wineries and restaurants, we drove 340 miles. We never charged the car during the trip as her Tesla’s range is over 400 miles. There are currently over 145,000 gas stations in the US. The number of locations with charging stations now exceeds 54,000. At the historic  growth rate of over 35% this would mean that the number of charging locations could exceed the number of gas stations by the end of 2026. It is also likely that the number of gas stations could decline as the install base of gas-powered vehicles declines.

Sales of BEVs have reached an inflection point.

In 2022 worldwide sales of light vehicles (passenger cars, SUVs and pickup trucks) EVs reached over 10.5 million units, up 55% year/year. This occurred despite the sales of all light vehicles declining slightly versus 2021.

To understand where this is going, we initially need to produce a forecast for total light vehicle unit sales (which, for simplicity we’ll refer to as “cars”) in 2030. I have assumed that by 2026 global unit sales would return to 2018 levels which was 93.7 million according to IHS Markit. I then assumed the volume would grow by 2% per year through 2030. Some would argue that given population growth, matching 2018 volumes 3 years from now is too conservative. Others will say we will not get back to that level. I believe this to be a middle of the road assumption.

The second question is what share will BEVs be of total auto sales? In the table below I show a range that varies from 30% to 70% (BEVs are over 10% in 2023). If we apply the Biden 50% minimum goal for the US to worldwide sales, then the 2030 number would be 50% of 101.4 million units or 50.7 million units. This would mean an 8-year compound growth rate of 26.6% for unit sales of BEVs (it grew about 60% in 2022). Obviously, this is not an exact science!

I expect Tesla unit sales to be about 8X 2022 levels in 2030.

In 2022 Tesla sold over 1.3 million BEV autos which was 17.1% of the BEV market. That is far from the full story as they did not participate in several large categories of vehicles: pickup trucks, low-cost autos, and sports cars. Their share was over 30% in the categories they did participate in. I believe that by 2030 Tesla will have added all three of these categories to its lineup. If we take the middle row and column of the above chart: BEVs have 50% market share and Tesla sells 20% of BEVs (which is 1/3 share lower than they currently have in categories in which they participate). That would mean Tesla will sell 10.14 million vehicles in 2030. If they did, the company would have an 8-year CAGR of 29%. This is well below the 50% growth they are tracking towards this year but of course the law of large numbers predicts a decline in high growth rates.  

Tesla Stock did not reflect strong expectations in 2022.

Despite revenue growth of over 50%, Tesla was one of the worst stocks in 2022. Partly this was due to fears that Elon’s acquisition of Twitter would be a distraction, partly it was due to the backlog shrinking and partly it was due to Elon liquidating a number of shares to finance the Twitter acquisition. In H1 2023 Tesla was one of the best stocks in the market (appreciating over 110%) as the backlog began to (slightly) expand again, Elon stopped selling shares (and promised to hold his position for the rest of 2023) and the Twitter acquisition became less of an issue to investors. It should be noted that as of September 10, Tesla shares have slipped by about 5% from the June 30 value over new fears that Tesla price cuts were hurting earnings. It was obvious to us that the price cuts were to leverage superior manufacturing cost and drive increased volume and this has in fact occurred, but Tesla will remain a volatile stock which is why premiums on Tesla calls are quite high.

Unlike some, we believe Tesla was smart to raise prices substantially in 2021 and 2022 while they could not meet demand. Then we believe they were smart to lower prices once their manufacturing capacity expanded, and backlog shrunk to a more normal level. Lowering prices places tremendous stress on the competition as Tesla has significant margin advantages over its competitors. Its net margins are still strong at lower prices, but many competitors don’t have the room to maintain margins at lower prices. Additionally, lowering prices on Tesla mass market vehicles meant that many Model Ys and Model 3s qualified for the US $7500 tax credit for electric vehicles that started on January 1, 2023. Nonetheless, the level of price decreases is worth monitoring as it does lower Tesla gross margins.

We expect Tesla unit sales to increase 45% to 55% in 2023.

Despite rising slightly in H1, the decrease in the Tesla backlog remains a concern to investors. 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, some investors have a concern that it will be difficult for Tesla to achieve or exceed its target of 40% vehicle sales unit growth in 2023. Given already announced sales in Q2, Tesla unit sales were up 60% in H1. However, this includes a very weak comp in Q2 2022 due to China being closed for part of Q2 last year. Still if the company merely replicates Q2 sales in Q3 and Q4 for existing vehicles and adds sales of the Cybertruck to this total, 2023 growth would exceed 45%. There are several factors that indicate they are likely to continue to increase sales sequentially:

  1. In Q2 Tesla actually shipped more cars than it produced despite increasing production, while backlog remained relatively stable. 
  2. Historically Tesla has seen demand increase sequentially in virtually every quarter. If we assume a 7% increase going forward, then units will be up over 50% year over year in 2023 without any Cybertruck sales.
  3. The Tesla CyberTruck has a waitlist that exceeds 1.5 million vehicles. On August 16 Electrek reported that “truckloads” of Cybertrucks were spotted being delivered. These would not be for consumers but rather for final testing. Tesla has indicated that it will be hosting a launch date for the vehicle and speculation is that it will be quite soon. They then will begin building towards volume production starting in Q4. If existing product sales fall short of the 7% sequential increase in Q3 and Q4, sales of the CyberTruck could make up for the difference as these sales will be incremental to the current run rate for existing vehicles.
  4. 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.

Despite a reduction in its backlog in 2022, 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 a comparison Toyota worldwide market share is over 13% and VW is not far behind. We estimate that Tesla’s share of BEVs in the categories it plays in is over 30%. Once it launches the Cybertruck it will increase its available market (TAM) substantially. But it will still need to launch a low-priced vehicle (in the $25,000 – $30,000 range) and a sports car (which it is working on) over the next 3-5 years to address the total market. As the world transitions to electric vehicles, we expect Tesla’s share of all auto sales to rise substantially even as it declines in dominance of the electric vehicle market. When the CyberTruck begins shipping, Tesla total backlog is likely to increase to over 1.6 million vehicles. And the CyberTruck current backlog isn’t expected to be fulfilled until late 2027! 

Tesla Margins

Tesla gross margins declined in Q1, as price decreases had an impact. In Q2 Tesla made further price decreases but this was partially offset by improved efficiency in newly launched factories in Berlin and Texas. While lower vehicle prices in 2023 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;
  • Add-on sales are likely to offset a portion of price 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.
  • A decline in gross margins can be at least partly offset by SG&A declining as a percentage of sales as revenue growth is likely to be higher than any increase in SG&A.

Revenue in the Semi category could surpass $10 billion in a few years.

To date the Tesla Semi has been produced in very small volumes and limited production capacity will mean deliveries will remain low during the next few quarters. We believe the ramping of Semi production will begin in late 2024 as the company only has a small number in customers’ hands today (essentially for test purposes). 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 appears lower than any competitive products. 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 2025 (which would represent potential incremental high margin annual sales in the $8-$10 billion range). While this is ambitious, the demand could exceed that 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.

Tesla Expects to launch a new Roadster in 2024

The new version of the roadster is being developed but it’s unclear when it will be ready for production as the target date has slipped multiple times. Right now, Tesla expects the launch to be in 2024. Once it launches, it will become another source of incremental demand at high margins. The early claims are that it will have a driving range of over 600 miles (at reasonable speeds), a top speed of 250 miles/hour, go zero to 60 in 1.9 seconds and cost about $200,000 for the standard model. This would make it faster than a McLaren.

The Bottom Line: Tesla should continue to have accelerated revenue growth in Autos.

This all points to solid revenue growth continuing (but at a lower level than unit sales growth in 2023), strong GMs in 2023 and beyond, and earnings escalation likely faster than gross margin dollar growth. While the company has reduced pricing, the ability to sell greater dollars in software should help maintain strong AOV and gross margins.

Tesla is not a one trick pony – it has several other potentially large revenue streams.

There are numerous other revenue sources for Tesla, especially on the energy side given its strong solar offerings and best-in-class power walls. Tesla also is a leader in automated driving and should that reach commercialization for “driverless taxis/driver services” the company is well positioned to add a substantial revenue stream. The discussion above regarding charging stations did not include the fact that Tesla is the runaway leader in this category (it just reached 50,000 units deployed) and its technology is probably going to become the standard. So, while I believe the vast majority of charging will take place in the home, Tesla will add another revenue stream from their infrastructure. Recently GM, Ford and Rivian have all decided to move to the Tesla charging technology.

Finally, there is some possibility that Tesla’s Optima Robot project will, at some point in the future, lead to launching smart robots that can perform numerous tasks. The company has taken its AI developed for autos as well as the variety of sensors integrated into a vehicle and transformed them to apply to robotics. At their AI day 11 months ago, they were able to demonstrate a humanoid alpha version that could walk with knowledge of what was in front of it and around it. The robot could also pick up objects and perform other simple tasks. We expect a significant leap forward at this year’s AI day scheduled for September 30. Elon, who tends towards optimistic thinking, has stated that he believes revenue from the Optima could exceed Auto revenue at some point in time!

A few comments on Rivian.

Rivian has gotten quite a bit of press regarding its opportunity to be one of the leaders in BEV pickup trucks and SUVs. The Rivian R1T electric pickup truck has recently earned the J.D. Power award for the most satisfying experience among BEVs (Tesla was second). The study, released in February, benchmarked EV owner satisfaction with critical attributes that affect the EV ownership experience. Reviewing 2022 and 2023 model year battery electric and plug-in hybrid vehicles, EV owners found R1T to be best among premium battery electric vehicles for driving enjoyment, vehicle quality and reliability, service experience, interior/exterior styling, cost of ownership, ease of charging at home and accuracy of stated battery range.

Cars.com reviews gave Rivian a 5.0 out of 5.0 rating with 100% of customers saying they would recommend it. A second review site, Edmunds, with a minimal number of reviews, was less favorable as most reviewers rated it highly, but several reviewers liked the vehicle but were dissatisfied with the quality of service. We believe the JD Power survey to be the most reliable. The strong customer experience positions the company for accelerated top line growth. In Q2 revenue was up over 200% year/year and unit sales increased 59% sequentially. Rivian also increased their guidance of how many vehicles they will ship this year to 52,000. Despite the Ford F150 pickup being touted as the clear leader in the category, CNBC reported that Rivian actually sold more electric pickup trucks in the US in H1 than anyone else. In a recent survey by Car Guru, 43% of potential truck buyers said they favored buying an electric vehicle.

Rivian also has an order to build 100,000 electric vans for Amazon. Amazon says it has taken delivery of 5,000 already and I have recently seen a few on the road in the SF Bay Area. I asked the driver of one what she thought of the product. Her reply was that it was quite an improvement versus her prior van. In searching for other products that compete there appear to be numerous others manufacturing this type of product. It’s hard to tell if the Rivian van has an overall advantage but it does seem to have the longest range of any that I found. This appears to be a very large opportunity for Rivian as the price of its vans start at $60,000 so the existing Amazon order is worth at least $6 billion (5.4X Q2 Rivian revenue) and Amazon could decide to expand the order. The fact that its competitors does not include Tesla puts Rivian in a strong position.

Given the quality of its vehicles, Rivian is well positioned to scale if they can fix their economics. In Q2 gross margins on its vehicles improved by $35,000/vehicle over a year earlier but still came in at a loss of $412 million. If the company can move to profitability (a target it expects to reach in late 2024) without compromising vehicle quality, it could be a very strong performing stock. The risk that they don’t get there before running out of cash has kept the stock value low.

Lucid appears to be struggling.

Lucid produces a very high-end electric sedan that directly competes with the Tesla Model S. The Lucid Air is more luxurious and has a longer driving range than the Tesla but also costs more. The product gets great reviews from magazines like Car & Driver who said: “ As luxury electric sedans go, the Air is a home run, delivering a posh overall experience with an unbeatable driving range.” Given such accolades many thought the Air would be a worthy competitor to Tesla. However, consumers have not embraced the product as their reviews are just OK. Cars.com reviewers gave it an average rating of 3.3 out of 5 and only 46% of those reviewed said they would recommend it. As a comparison the Tesla Model S received a 4.0 average rating and 80% of reviewers said they would recommend the car. Admittedly, the number of reviews was small, but this is still an issue for Lucid.

Lucid appears to have lost momentum in the marketplace as Q2 sales of 1,404 units were flat compared to Q1 and fell well short of Wall Street expectations of 2,000 units. This also put into question whether Lucid was successfully converting the 28,000 reservations it had previously disclosed.

On the positive side, Lucid is extremely well funded and struck two interesting deals in the quarter:

  1. To supply Aston Martin with power trains, battery systems and related technology in a deal worth $232 million.
  2. To begin sending cars to Saudi Arabia which may help relieve the company’s inventory build up as it produced over 1,700 more vehicles than it sold in H1.

Both deals must be taken with a grain of salt as the Saudi Arabia Public Investment Fund is a major backer of both Lucid and Aston Martin.

Lucid will be launching new lower priced vehicles going forward so it still remains a company with potential given its ample capital, quality technology and well-designed vehicle. But, unlike Rivian which has carved out a niche where Tesla is not a direct competitor (now or in the near future), Lucid will have to find a way to be more successful versus this dynamo.

Top Ten List for 2023

Mike Kwatinetz covid-19, Economics, Golden State Warriors, Predictions ,

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.

Top Ten List for 2022

Mike Kwatinetz Economics, NBA, Predictions, Stocks, Technology ,

The past year has been extremely busy for me and the decline in blogs produced has been one of the consequences. On the one hand, I’m mortified that my annual Top Ten list has been delayed by 2 months. On the other hand, it turns out that the steep decline in tech valuations affords an opportunity for acquiring recommended stocks at much lower cost than they were on January 2. Because I don’t want to delay recommendations further, I am going to publish the recap of 2021 picks after the new Top Ten blog is out. Suffice it to say the recap will be of a down year after posting my best year ever in 2020, but that means (at least to me) that there is now an opportunity to build a portfolio around great companies at opportune pricing.

Starting in November of 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 2022, the 6 stocks I’m recommending are Tesla, DocuSign, Amazon, Zoom, CrowdStrike and Shopify (the only new one on my list).

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 the last 14 months as illustrated in Table 1.

The average revenue gain in the last quarter reported by these companies was 43%, while the average stock in the group was down 17%. It should also be noted that Amazon reported that its major profit driver, AWS, had grown 40% while eCommerce had been relatively flat year over year and the stock reacted positively due to the AWS increase. Over time I expect share performance to be highly correlated to revenue growth, but clearly that has not been the case for the past 14 months. Shopify, Zoom, DocuSign and Amazon had revenue growth largely distorted by Covid, with 2020 growth being well above their norm and 2021 growth coming down dramatically. This caused their stocks to plummet as the interpretation of 2021 results was that long term growth had slowed. Yet in all cases the 2-year compound growth rate was well above the previous norm.

Table 2 highlights this abnormality.

In Q3 2019, Zoom’s revenue growth was 85%. Such a high rate of growth usually declines each year barring some abnormal situation. Instead, the growth rate soared in 2020 and the jump was followed by additional growth in 2021. The 2-year CAGR was 151% and Zoom had over 6 times the revenue in Q3 2021 than it did 2 years earlier. Yet, its share price is now roughly only 10% above where it was 2 years ago and down 63% from January 1, 2021. While Zoom is the most extreme situation of the four companies in Table 2, each of the other three have had a similar whipsaw of its revenue growth rate and in each case its stock soared in 2020 only to heavily trail revenue growth in 2021 despite its 2-year CAGR being above pre-pandemic levels in every case. While revenue growth at Tesla and CrowdStrike were not impacted in a similar way by the pandemic as both had more normal revenue growth patterns in 2020 and 2021, they still saw share performance significantly trail revenue growth for the past year.

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 that the roughly 59% average decline in revenue multiple among these stocks represents the bottom…as I never know where the bottom is.

2022 Stock Recommendations (Note: base prices are as of February 25, 2022)

  1. Tesla will continue to outperform the market (it closed at $810/share)

a. Tesla demand has far outstripped supply, as backlog increased steadily during 2021. And this is before the Cyber Truck with it’s over a million pre-orders, has come to market. This has been partly based on a substantial surge in demand and partly due to a shortage of some parts. While Tesla has made and will continue to drive up capacity by launching multiple new factories, supply of parts has prevented the factories from operating at capacity. Rather than overspending to secure more supply (a major error by Peloton), Tesla has chosen to raise prices and to prioritize production of more expensive (and more profitable) versions of its products. As of December 31, wait times for the standard Model 3, Model Y and Model S were approximately 10-11 months while the more expensive high-performance version of each had delivery times of 2-3 months. For the Model X, delivery dates were even longer. As we forecast in prior letters, Tesla gross margins have been rising and in its most recently announced fourth quarter were the highest in the industry. Yet, we believe they will still go up from here as:

  • Tesla, like Apple did for phones, is increasing the high margin software and subscription components of sales;
  • the full impact of recent price increases is not yet in the numbers;
  • its factories are not yet operating at full efficiency; and
  • Tesla will have lower shipping cost to European buyers once the Berlin factory begins to ramp.

b. Cyber Truck preorders are now estimated at over 1.25 million units (approximately $79 billion in sales value) according to a fan tracker site, or 50% more potential revenue than 2021 total revenue. Obviously, some of the orders will be cancelled given the long wait times before delivery, but still, this virtually assures large revenue increases for 2022 and 2023, only gated by obtaining enough supply of parts. The Cyber Truck is not expected to ship until mid-2022 and is not material to meeting revenue forecasts for this year. The Tesla Semi appears close to being ready to go into production, but battery constraints will probably mean any deliveries will be truly minimal for Q1 (Pepsi expects to take delivery of at least 15 in the near term). The Berlin factory, a key to increasing its share in Europe, will likely begin manufacturing in the first half of 2022. What this all points to is high revenue growth continuing, stronger  GMs in 2022, and earnings escalation likely faster than revenue growth. While revenue growth is gated by supply constraints it should still be quite strong. And the high backlog not only assures that 2023 will be another high growth year but also means there is little pressure on Tesla pricing.

  1. Shopify will outperform the market (it closed at $677 per share)

Shopify, like Amazon, Zoom and DocuSign experienced elevated growth in 2020. This was due to Covid keeping people out of stores (many of which weren’t even open). If we look at pre-Covid growth the company’s revenue increased by 45% year/year in Q3 2019. A year later revenue growth had escalated to 96% due to Covid.  In Q3 2021 growth was 46%, returning to pre-Covid levels. The compound 2-year rate of growth was 70%. If Shopify can continue at a 35-40% revenue growth rate it will mean it has absorbed its higher level of revenue and is growing quite nicely from there.

Shopify has established a clear leadership position as the enabler of eCommerce sites. Its U.S. eCommerce market share, at 10.3% in 2021, is second to Amazon and well ahead of its closest competitors Walmart, eBay, and Apple. Net revenue retention for the company continues to be well 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.  I expect continued growth to be well over 30% for several more years given three things:

a. Ecommerce should continue to take share from offline.

b. We expect Shopify to continue to gain share of Ecommerce.

c. Shopify will leverage expanded services leading to higher revenue per client.

In 2022 revenue growth is expected to be lower in the first half of the year than the second due to the benefit Covid had on the first half of 2021 and some changes Shopify made in its method of charging customers that took effect in the second half of 2021.

  1. CrowdStrike will outperform the market (it closed at $182 per share)

CrowdStrike continues to gain substantial share of the data security market. Given its leadership position in the newest technology coupled with what is still a modest share of its TAM, the company remains poised for continued high growth. This coupled with over 120% net revenue retention for 12 straight quarters (primarily driven by expanded module purchases) makes CrowdStrike a likely long-term grower at over 50% per year.

The recent threats by Russia to create a Cyber attack on the U.S. could be an additional boost to the entire security industry. CrowdStrike stands to be a disproportionate beneficiary as it has the most advanced technology for defending companies against such attacks.

  1. Amazon will outperform the market (it closed at $3076 per share)

Amazon, like Shopify, benefitted from the substantial number of people who shopped from home in 2020. This caused an expansion of its growth rate from 24% in Q3 2019 to 37% in in Q3 2020. In Q3 2021 growth was down to 15% against the tough compare. Looking at the 2-year compound rate the company appears to have had a modest benefit to growth. We expect the company to return to a 15-20% growth rate in the second half of 2022. This would mean that it has absorbed extra revenue and returned to the normal curve of growth declining. One thing that helped the stock was that higher margin Amazon Web Services (AWS) grew at 40%, much higher than modestly profitable commerce. AWS continues to be quite attractive relative to its peers and its quality and sophistication continues to improve.

A second potential driver for the stock is that new CEO Jassy may decide to increase the focus on earnings growth which is available to Amazon if it chooses to do so. If he does that could be a catalyst to share appreciation. To that end, on the Q4 earnings call the company announced that it would be increasing the cost of Prime by about 17%. This increase will go into effect in Mid-February for new members and in Mid-March for existing members. The impact will roll out over 12 months as existing members renew their annual membership. Despite this increase, Prime remains a distinct bargain as it not only includes free shipping but also a number of other benefits such as video streaming of movies and TV shows, some free eBooks, discounts at Whole Foods and more. Given that Prime has over 200 million members, the increase adds over $4 billion to revenue once it fully rolls out or about 1% of revenue. While this may not appear to be that much, it is worth about $8 per share in pre-tax earnings.

  1. DocuSign will outperform the market (it closed at $115 per share)

DocuSign experienced some of the up and down in growth that Zoom did but to a more moderate extent. Its “normal” pre-Covid growth rate of 40% in Q3 of fiscal 2020 escalated to 53% a year later and then fell back down to 42% in its last reported quarter. As with other high growth stocks DocuSign’s rate would normally have fallen, so the 2-year compound rate of 48% was quite strong. Yet, as I write this letter, the stock is down by over 50% in the past year despite revenue increasing by 42%. This means the multiple of revenue has fallen by about 64% in a year.

As is normal for high growth companies, I expect DocuSign to continue to have a modest decline in revenue escalation from last quarter but believe growth will continue to be above 30% for several years as net retention among enterprise customers (which is 88% of revenue) is over 120% and the company continues to add new customers to this group at a solid pace.  DocuSign is the dominant player in the use of eSignature and other management tools for documents. The use of these tools will be just as important in a post-Covid world.

DocuSign continues to add initiatives to keep Net Retention at or near the 120% level. These include growing its partnership with Salesforce, launching a new release of its software, Agreement Cloud which in addition to eSignature also includes the full cycle of contract creation and management. The company is also working on creating an eNotary product.

  1. Zoom will outperform the market (it closed at $125 per share)

Zoom is a company that has had its revenue trajectory impacted the most by Covid. Before the pandemic, the company was growing revenue at 80%+ in 2019. Such a high growth rate would normally decline the following year but when Covid struck Corporate demand increased by a higher rate than normal and individuals flocked to Zoom in order to maintain some visual contact with friends and family. As a result, Zoom growth peaked at an unheard of 365% in Q2 of fiscal 2021 (reported in calendar Q3 of 2020). As people subsequently began leaving their homes Zoom’s growth was impacted. The corporate side of its business continued to have robust growth with Net Revenue Retention of over 130% as business customers from a year earlier increasing their spend by over 30% including churns. In addition, Zoom had a net add of new customers of 18% of the prior year’s total. Putting those together means that revenue from business customers grew about 45% and continued to grow about 10% sequentially while growth of the consumer side was flattish to slightly down sequentially. Combining the two trends meant that overall growth fell to 35% year over year in Q3 of fiscal 2022 and is expected to decline further in Q4. Looking at the 2-year compound growth rate for revenue in Table 2, one can see that Zoom experienced an elevation to over 150%, nearly double their pre-covid level. We believe that over the longer run Zoom can grow over 30% once the corporate side of its business becomes a bit more dominant and the consumer side begins to show moderate sequential growth. And we expect that sequential growth will begin to rise at some point during calendar 2022 (its fiscal 2023).

GMs were over 81% in FY 2020 (ending January 31, 2020), pre-Covid. The impact of free use to schools with students being on Zoom 8 hours a day, a major expansion of consumer free users, plus paying users expanding use without generating extra revenue (there is no charge for increasing usage) caused GMs to decline to under 70% in FY 2021. By Q3 FY 2022 GM had returned to 76%. We believe further improvement in GMs is inevitable as Covid declines and usage rates diminish without impacting revenue. This should mean that earnings increase at a faster rate than revenue assuming the company keeps G&A growth at or lower than revenue growth.

2022 Non-Stock Invitations

  1. Republicans will recapture at least one of the Senate and House in the Interim elections

Since the Biden administration has taken power, inflation has surged to its highest rate since the Carter administration, the Ukraine crisis has emerged, Covid cases have jumped and Biden leadership and mental sharpness have come into question. While several of these issues may have come to the front no matter who was president, an ABC News/Washington Post poll shows the electorate clearly is dissatisfied. Biden’s approval rating has fallen to 37% and people believe by over a 2 to 1 margin that the Republicans would do a better job handling the economy.  The poll results show that if the House elections were held today, 49% would vote Republican and 42% Democrat. Given how tenuous the Democrats majority is, this would likely lead to a change of control. It is only late February so there is still time for this to change, but many of these issues, especially the economy, may be hard to turn before the November election.

  1. The travel industry will experience robust growth starting in the summer of 2022

The travel industry has had a pretty rocky 2020 and 2021 as Covid elicited substantial fear of boarding a plane, traveling out of the country and/or taking a cruise. In 2021, we did see a return to travel within the U.S. and it was accompanied by increasing prices of hotel rooms and restaurants. It seems clear (to me at least) that people are worn down by Covid and appear ready to resume some of their prior vacation habits. While new Covid cases are still at very high levels (but falling rapidly), the current version is much less deadly than prior ones. In my group of friends, several of us have planned a trip to France in May which will be the first time back in Europe for any of the 4 couples since 2019. While I’m less certain of when cruise lines will be back to normal, I expect them to see some renaissance this year. The only fly in the ointment is how serious the Russian crisis becomes. As of now I believe it will be restricted (from a military point of view) to the Ukraine.

  1. PG&E and other utility companies will battle to dramatically increase what they charge those who convert to solar

There is a massive conflict between the drive to replace energy received from the grid with solar panels. On the one hand the U.S. government provides a 26% tax rebate for installing solar panels. And states like California are pushing to drive more solar through a net metering law (and in the past tax rebates). Also, California is now mandating roof solar panels for all new homes. On the other hand, utility companies like the three in California are battling to increase charges to those that install solar as an offset to the revenue they would lose. The Solar Rights Alliance estimates that “going big on Solar” could save American households over $473 billion over 30 years, whereas “doubling down” on new powerline installation would add $385 billion in cost to American households. When a household converts to solar, energy companies lose revenue and these companies are intent on increasing the cost to solar users to offset this.

Net Metering means a household can sell back excess energy produced to their utility company, which in turn offsets any cost they incur on days when their solar falls short of needs and they need to buy from the utility. The dollars they were entitled to by selling back is then deducted from the bill for energy used. Before 2016 the price the utility company paid for the excess they bought was equal to the price they sold energy back to the consumer. As more homes installed solar the energy companies pushed for a change and in 2016 NEM 2.0 was passed. This allowed the utilities to charge $ 0.03 per kWh for power they sold back to consumers. It also added an interconnect fee of $145 or more to PG&E and different amounts for the other California utility companies. Further, it established a policy of varying rates based on the time of day (which meant higher charges on energy purchased during the middle of very hot days).

Still, as more and more households install solar (including all new homes), the utility companies view it their right to be able to increase charges so they can grow revenue. There has been a push before the California Public Utilities Commission to pass NEM 3.0. It would allow the 3 major utility companies to charge between $56 and $91/month to any home with a new installation of solar. Additionally, it would slash the credit for selling back energy. If it had passed this would have added significant cost to homes with solar and likely reduced the number of existing homes that install it by 70% or more. For now, the public furor over NEM 3.0 caused the PUC to postpone action on this indefinitely. Instead, a large rate increase was granted to PG&E to help pay for remediating their negligence that contributed to California fires.  But this battle is far from over!  I’m expecting some sort of political compromise on new charges to solar homes to occur when the furor dies down. It likely will lower the added charges from the prior proposal but still increase the cost. While I am predicting this increase in 2022, it may not happen until 2023.

  1. If Green comes back at full capacity the Warriors will win the NBA Championship

As usual I had to have my one fun pick. Clearly this is not a “gimme” and maybe shows my fan bias. In fact, the Warriors have serious issues even getting to the championship game as the Suns have been playing great and Memphis is on the rise and easily could beat out the Warriors for second in the West. This means the Warriors could need to overcome home court advantages for each of those teams assuming each of the three wins in earlier rounds. But, before Green was injured, the Warriors were the top defensive team in the league and also playing quite well on offense and Klay Thompson had yet to play.  Since his injury Kuminga has emerged as another strong cog in the Warrior wheel and Klay appears to be working towards his former production by the playoffs.

In last year’s top ten I pointed out that Wiggins was likely to shine for the Warriors and he has certainly done that on offense and defense this year. Despite a so-called slump, Curry is still the best shooter on the planet and will likely return to full form when Green returns as its no coincidence that his tail-off started under the pressure of breaking the 3-point scoring record but has mostly been with Green out. Poole has developed into a strong 6th man who is capable of providing a scoring boost when needed. Looney could benefit from a little easing of his minutes coming into the playoffs as he was playing his best basketball ever for most of the season. Iguodala should be very additive in the playoffs, assuming he is healthy. Finally, Gary Payton is a game changer on defense and Kerr has been using him very effectively.

Recap of 2020 Top Ten Predictions

Mike Kwatinetz covid-19, Golden State Warriors, Predictions, Stocks, Technology, Unicorns , , , , , , ,
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)

  1. Tesla Stock which closed 2019 at $418/share and split 5 for 1 subsequently
  2. Facebook which closed 2019 at $205/share
  3. DocuSign which closed 2019 at $74/share
  4. Stitch Fix which closed 2019 at $25.66/share
  5. Amazon which closed 2019 at $1848/share
  6. 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 5th 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:

  1. The younger players did develop last season, especially Pascal
  2.  The Warriors did get a very high draft choice and at first blush he seems like a winner
  3. 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 9th, 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.

My approach on public market investing

Mike Kwatinetz Metrics, Predictions, Stocks, Technology, Valuation ,

I have always taken a research driven, multi-pronged approach to identifying attractive publicly traded equity investments, and after reflecting on this approach with a new fund that I am starting, I figured that it would make for an interesting blog post to share this with a broader audience. The companies that I have covered through previous blog posts have been identified through this process. As you likely know if you made some investments based off of my suggestions in the past, they have performed very well!

My Screening Process

I begin with a screening process as follows:

  1. Discover trends that are disruptive to entrenched market participants, expected to continue for over five years, and relate to very large markets
  2. Identify companies that are strong beneficiaries of these trends; and
  3. Evaluate these companies’ competitive advantages that stem from one or more of:
    • superior technology often protected by patents,
    • strong emerging brand,
    • network effect of having built a massive connected audience,
    • high quality leadership,
    • products that are very difficult to replicate, and/or
    • advantageous business model

Companies are identified that pass the above screening. Then I apply a filter to reduce these matches to ones that also are already generating or have an ability to generate strong profits. I believe that the most important metric to evaluate companies that have yet to develop mature business models is contribution margin, i.e.: gross margin minus customer acquisition cost. We have covered contribution margin in past blog posts. Check our post in January 2020 which contains our discussion of sophisticated valuation methodology for more background on how I see this as a key metric for evaluating business models.

Companies passing the above screen are rare and, thus, are both difficult and time-consuming to identify. Each company selected from those that passed the screening will also need to have well above average revenue growth for their respective stages.

My experience indicates that great returns will be realized over a long period of time from companies that have the key attributes described above and, therefore, I expect, generally, to hold the core of each of my positions for an average period of five years or more. This doesn’t mean never selling any shares, but rather holding the majority of shares for that period. I augment my equity investments in portfolio companies by writing both call and put options or other derivatives (we covered an example of this recently with Zoom in my 2020 predictions). Doing this hedges risk of short-term market fluctuation and generates income from option premiums going to zero over the life of the option. Given my concentration on relatively few securities of high growth companies, it is expected that volatility in my portfolio could often exceed that of the overall market. Therefore, I believe it’s important to avoid margin borrowing as this would increase risk and volatility beyond what I think is an acceptable level.

Applying the Strategy to Investing

The first step in my strategy is to identify longer term trends that are disruptive to entrenched leaders of large markets. I believe the following qualify:

  1. Growth of eCommerce: Online purchasing will gain share for another 10 years or more
  2. Shift of services from physical, in-person to virtual: This reduces cost and adds convenience and should persist for many years
  3. Use of video conferencing in place of older audio conferencing: Will continue to further penetrate businesses and also emerge as a “must have” for individual households
  4. Online advertising: It will continue to gain share from other forms as it allows for more precise measurement of effectiveness and promotes immediate ability to purchase
  5. Shift from old generation autos to eco-friendlier (i.e. electric) with software capabilities tightly integrated: It is in its early stages and will gain increasing traction for several decades to come
  6. The entire online security industry will 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
  7. Web Services will continue to experience double digit growth: Since its directly tied to Internet traffic driven by increased eCommerce, escalation of video, social and virtual services

Several companies that I have selected (and outlined in the past) benefit from more than one of the 7 identified trends and all are one of the dominant players in their particular arena. It should be noted that the arena may be more specific than the trend.

For example, Online advertising has distinct leaders in overall social (Facebook), search advertising (Google), Visual advertising (Pinterest), eCommerce ads (Amazon) and programmatic (The Trade Desk). So, while these 5 companies compete for advertising budget, they each are the dominant brands in their sub-sector with massive networks of users that are difficult to replicate.

Picking the winners

In the first section of this blog, I highlighted six different types of competitive advantages I look for. The companies that I have recently invested in have three or more of these advantages, and on average qualifies for roughly 4.5. On the leadership side not only do all have very strong leadership but virtually all are led by their founder who is an early innovator in their sector.

One other major consideration recently has been the impact of the pandemic. There are three companies that I have previously covered in the blog that I feel benefit strongly: Amazon, DocuSign, and Zoom. Both Peloton and Shopify would be major additional beneficiaries. When the pandemic ends there is widespread views on how such companies will be impacted. On the one hand, many analysts believe some or all of these will experience a reduction in revenue against strong comps. Others, including myself, think that behavior has changed, so while massive growth experienced during the pandemic won’t be replicated, most, if not all of them will continue to grow at a more “normal” rate. The four advertising companies I mentioned previously: Facebook, Google, Pinterest and The Trade Desk have all been impacted by the loss of advertising from major business segments like travel, live events (and associated ticket sellers) and brick and mortar retail. Since Amazon advertising revenue is limited to online sellers it is not affected by loss of ads from these sectors. My expectation is that when the Shelter-in-Place requirements are substantially eased, all four of these companies will experience a jump in advertising revenue. As we reach April of 2021 this jump will be compared to depressed comps and all four should experience above normal growth.

Of companies that are in my 2020 stock pics, surprisingly, Tesla has appreciated well over 600% despite its revenue being lower than pre-pandemic expectations. I believe this is mostly because of the certain shift taking place towards software enabled electronic cars but the stock has also been helped by inclusion in the S&P index. The other company negatively impacted by the pandemic is Stitch Fix. On the one hand, it has undoubtedly gained share as it offers a modern online method of shopping to its very large base of customers, but it is also obvious that people are just not buying that many items of clothes during the pandemic. I expected Stitch Fix to be a substantial beneficiary when Shelter-in-Place is eased, but the market is already anticipating this as we’ve seen it’s begin year value of $25.66, which fell dramatically earlier in the pandemic, rebound nicely to a price of $69 in December 2020…a 170% appreciation year-to-date.

I have also been examining several companies that had recently IPO’d as younger public companies tend to have higher growth rates which in turn creates greater potential future appreciation. So, I considered the various companies that had come public in 2019 to see which ones met my screens. Investing in Lyft and Uber, post IPO, had little interest for me. On the positive side, Lyft revenue growth was 95% in Q1, 2019, but it had a negative contribution margin in 2018 and Q1 2019. Uber’s growth was a much lower 20% in Q1, but it appeared to have slightly better contribution margin than Lyft, possibly even as high as 5%. I expected Uber and Lyft to improve their contribution margin, but it is difficult to see either of them delivering a reasonable level of profitability in the near term as scaling revenue does not help profitability until contribution margin improves. So, I passed on both which proved the right decision as Lyft is still well below the first day’s closing price of $78.29 post-IPO. Uber is now up 27% vs its first day closing price (roughly the same as the S&P index) as food delivery has proven a great business for them during the pandemic. The first of the 2019 IPO class that I bought was Zoom Video, which had a contribution margin of roughly 25% coupled with over 100% revenue growth. It also seemed on the verge of moving to profitability. Four others piqued my interest: Pinterest, Peloton, Slack and CrowdStrike. All of these were growing revenue at a 40% or higher rate, had solid business models and met my other criteria. I’ll discuss these in more detail in my following posts but, on average, they are up well over 300% this year …stay tuned for my 2021 predictions!

A Counter Theory to Potential Recession (during week 26 of Shelter in Place)

Mike Kwatinetz Economics ,

Consumers have more money available to spend – not less

Much of the public dialogue concerning the economic effect of Covid19 has centered around the large number of people who have lost income, with the conclusion that the US will potentially experience a continued recession going forward. What seems to be lost in the discussion is that the 90% of the labor force that is employed is saving money at an unprecedented rate. This has occurred partly through fear of future loss of income but mostly by a reduction in spending caused by the virus. For myself and my family, our spending has been involuntarily reduced in the following areas:

  1. Personal care: haircuts, beauty parlor, nail treatments, massages, etc.
  2. Cleaning services: we are wearing very casual clothes that get washed instead of going to the cleaner (who has mostly been unavailable anyway).
  3. Vacations: our last vacation was in December. We haven’t been on a plane since the pandemic started and cancelled two vacation trips.
  4. Purchasing clothes: I have bought some items online for future use (because they were at major discounts) but being at home means I don’t really need any new clothes.
  5. Restaurants: before the pandemic I was eating breakfast and lunch out every weekday at or near my office and my wife and I ate out lunch and dinner on weekends. Additionally, I normally have additional business dinners several times a month. Instead, we are ordering food in on weekends from local restaurants we wish to support, but the cost is much lower than when we ate at the restaurant. Many of the people we know haven’t even ordered in from a restaurant.
  6. Transportation: these expenses have been virtually eliminated as I am not commuting to my office, take no Ubers and rarely drive anywhere other than to pick up local takeout food.
  7. Entertainment: such expenses have been close to eliminated other than occasionally purchasing a movie for home consumption.
  8. Medical/Dental/Optical Services: In my case medical and dental expenses have remained the same but many others have seen them reduced as access to doctors and dentists has been curtailed.

The only expenses that have increased are paying for delivery of food instead of picking it up ourselves at a supermarket and our new Zoom subscription…but at $12/month that hardly counts. I believe my family is representative of the 90% of people who still have their jobs at no reduction of pay.  In fact, according to Statista, the savings rate in March through June increased to an average of 22% versus 7.9% in 2019. Using this data, I estimate that by the end of August this amounted to approximately $1.2 trillion in above normal savings as compared to last year’s “normal” savings rate. Since stay at home is unlikely to end in many places by the end of August, this number is likely to grow.

Post Pandemic: will some areas of savings persist?

Survey data of companies indicates that there is likely to be an increase in the number of people who work from home once the pandemic ends A recent survey by Global Workplace Analytics estimates that the U.S. will see between 25-30% of the workforce working from home multiple days a week by the end of 2021, up from less than 5% who were working from home at least half-time or more before the pandemic. Since working from home will continue to offer some savings in spending this could add to the “pot” of available dollars to be redeployed. There also may be some people who remain reluctant to fly or go on a cruise. We don’t expect these incremental cost savings to be removed from commerce but rather to be redeployed.

What I believe will occur post-pandemic

While some people will take advantage of their lower cost during the pandemic to pad their savings, it seems likely to me that a substantial portion of the “above normal” accumulated savings will be spent. I believe that such spending will be divided between satisfying pent up demand for items like clothing and vacations and new demand for luxury items. The pent-up demand will start with numerous parties as people are able to once again have human contact, but it also is likely to consist of increased purchases of clothes, more visits to restaurants and rescheduling of missed vacations.

I think that some portion of these savings will also be used on furniture (and perhaps even full remodels), art, and increased purchases of luxury items. After all, people can easily feel they deserve a reward for all these months of suffering. It is apparent that many people are already adding to their online budgets for furniture, décor and art as Wayfair has seen a large spike in revenue. While Wayfair results may be due to increased marketing spend, Azure portfolio company Chairish, has also had a very large spike in revenue without such an increase in marketing.

Has the pandemic caused temporary changes in buying habits or merely accelerated trends that were already in place?

The pandemic caused a number of radical changes in behavior, including:

  1. Most people working from home and rarely, if ever, going to their office.
  2. The vast majority of people ordering almost everything online instead of visiting a store.
  3. Shifting to video calls with coworkers, friends and relatives as opposed to regular phone calls or face to face interactions.
  4. Working out at home instead of at a gym, where possible.
  5. Education moving to at home via Zoom.

These shifts favored eCommerce sites, delivery services, providers of video conferencing, home equipment providers, Telemedicine, web services providers, and many others. They devastated physical stores, especially large department stores, restaurants, local transportation services (like subway systems, busses, ride services), service providers like cleaners, beauty parlors, spas, and gyms, airlines, hotels, theaters and arenas, and sports leagues (including college sports). There was also a lesser negative secondary impact on the advertising and marketing sectors as companies with major demand losses curtailed their spend.

How Ya Gonna Keep ‘em Down on the Farm After They’ve Seen Paree?

This was a song in the aftermath of World War I highlighting the fact that farm boys, once experiencing a more sophisticated life and culture would find it hard to return to their old way of life. It could not be more appropriate for the current situation. The leap in how much nearly everyone in society is using eCommerce, video conferencing, schooling and working at home is accelerating trends that were already in place. In fact, for me:

  • Phone calls to friends that used to be audio calls are often Zoom video calls;
  • While my wife and I already were buying a great deal online, its now pretty much everything and when the pandemic ends our portion of purchases online will remain at an elevated level given the convenience and the availability of a larger choice of items
  • While I already had a home gym, many others are now substituting this for a gym membership
  • In the 25+ weeks I’ve been “sheltering in place” I visited my Menlo office for 2-3 hours on about 5 separate occasions. While I look forward to more in person meetings once we are back to normal, working at home is an option that I expect to continue to use with some frequency once the pandemic ends. I also believe that several Azure portfolio companies can reduce the number of in-person board meetings by alternating them with Zoom board meetings.

I honestly find it hard to believe that our society will not shift behavior in the same way as my wife, myself and companies in the Azure portfolio. After all, while most of us have suffered from lack of interaction with others, the pandemic has introduced many shifts that people find positive. With this, and keeping the larger available funds mentioned earlier in mind, here are some of my post pandemic predictions:

  1. Ecommerce share of the consumer wallet will be much higher than before Covid, but not as high as currently.
  2. Consumer spending for the near term will grow to a much larger amount than pre-pandemic days (by perhaps as much as 15-20%).
  3. Online Advertising Companies will have a banner year in 2021 as Ad spending resumes for industries that were impacted by Stay at Home. These include airlines, cruise lines, hotels, live events (sports, concerts, etc.), ticket sellers, physical retailers. As their spend resumes, players like Facebook, Google, Pinterest, Twitter and Snapchat will have elevated revenue versus comps from the depressed 2020 numbers.
  4. Video calls will INCREASE SHARE even compared to during the pandemic as the people who have experienced its benefits will find it hard to go back to plain audio, companies will see the economics of reducing travel by increasing the number of video meetings and about 25-30% of the workforce will continue to spend 2 or more days working at home. Additionally, companies will be more comfortable hiring IT staff in less expensive locations as they have seen the effectiveness of video vs in-person communication, and some colleges that previously only offered in-person education will augment their income by adding students that are taught remotely using video conferencing.
  5. Home remodels will have a renaissance from simply buying a new couch to completely redoing rooms or even the entire house.
  6. Suburban homes will increase in value (this appears to be already happening) as people value having outside space in case of a pandemic recurrence.
  7. Working from home will be at an elevated level vs pre-Covid but demand for office space will resume as workplaces will require more space per employee.
  8. More shopping malls will close as Big Box retailers close more stores (or in some cases cease to exist).
  9. The ability to sign and even notarize documents using the web will continue to see high growth in demand
  10. Vacations will resume, but for about a year or more there will be an increase in driving vacations
  11. More people than pre-Covid will take to wearing masks on a regular basis
  12. There will be a one year above normal bump in purchasing of luxury items like more expensive cars, expensive watches, new state of the art TVs

The Stock Market is already at Least Partly Discounting a Number of the Above Items

Many have been surprised at the resilience of the stock market during this crisis. It is important to remember that the Market discounts future results rather than past ones. So, I believe, many investors are looking at some of the above and factoring it into how to value stocks. The trickier issues involve stocks that have been beneficiaries of the pandemic but I’ll leave that for another time.

Soundbytes

  • In our January post of the top ten for the year we included Zoom as a stock buy in 2 ways. One was to simply buy the stock and the other was to buy the stock and sell both calls and puts. By June 30 the stock was at $253.54 per share and the call options (with a strike price of $80) was at $175 per share. Since the option premium was down to sub $2, I would have bought back the stock and the call options as there was little benefit to letting them ride as the IRR could not increase. But since I didn’t publish that then we can just assume I did that on September 1 where the premium was down to about $0.50. I can also buy back the puts at $0.40. That would mean I initially spent a net of $50.70 and received back $79.10, 8 months later. This translates to an annualized IRR of about 100% (on June 30 it would have been over 120%). Make no mistake, if you bought the stock and did not sell calls, I would continue to hold it as I expect another very strong (above analyst consensus forecast) quarter in Q3 which will be reported in early December.

2020 Top Ten Predictions

Mike Kwatinetz Ecommerce, Economics, Golden State Warriors, Marketing, Metrics, NBA, Predictions, Startups, Stocks, Technology, Unicorns , , , , , , , ,

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:

  1. Start with companies growing revenue 20% or more, where those closer to 20% also have opportunity to expand income faster than revenue
  2. Make sure the market they are attacking is large enough to support continued high growth for at least 5 years forward
  3. Stay away from companies that don’t have profitability in sight as companies eventually should trade at a multiple of earnings.
  4. Only choose companies with competitive advantages in their space
  5. 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)

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.

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:

  1. Buy X shares of the stock (or keep the ones you have)
  2. 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
  3. So, net out of pocket cost would be reduced to $1722
  4. A 20% increase in the stock price (roughly Amazon’s growth rate) would mean 29% growth in value since the puts would expire worthless
  5. If the stock declined 226 points the option sale would be a break-even. Any decline beyond that and you would lose additional dollars.
  6. 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:

  1. Revenue retention of a cohort was about 140%
  2. It acquires customers very efficiently with a payback period of 7 months as the host of a Zoom call invites various people to participate in the call and those who are not already Zoom users can be readily targeted by the company at little cost
  3. Gross Margins are over 80% and could increase
  4. The product has been rated best in class numerous times
  5. Its compression technology (the key ingredient in making video high quality) appears to have a multi-year lead over the competition
  6. Adding to those reasons 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):

  1. Buy X shares of the stock at $72.20 (today’s price)
  2. Sell Calls for X shares expiring January 15, 2021 at a strike of $80/share for $11.50 (same as last price it traded)
  3. 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 4th 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:

  1. 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.
  2. 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 7th pick. Since then their highest pick has been between the 28th and 30th 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 6th, 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 10th 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.

Recap of 2018 Top Ten Predictions

Mike Kwatinetz Predictions, Technology , , , ,

Have the bears finally won back control?

Oh, what a difference a month or 3 makes! If only 2018 had ended earlier…

I’m sure I’m not the only one who would have liked 2018 results to have been as of November 30th (or even better, October 1st). My stock forecasts were looking a lot better on those dates (and if I were smarter, perhaps I would have taken some of the gains at that point). My average gain was over 34% on October 1st (versus the S&P being up 8.5%) and was still holding at +10% as of November 30th with the S&P ahead 2.4%. Unfortunately, the year includes a disastrous December and my 4 stock picks ended the year at a 6.6% average loss. Since stock picks are always relative to the market, I take some solace in minutely beating the performance of the S&P which was down 7.0% for the year, especially since I favor very high beta stocks.

Before reviewing each of my picks from last year, I would like to provide a longer term view of my performance as it has now been 5 years that I’ve published my blog’s stock picks. Even with a down year in 2018 my compound gain is 310% versus an S&P gain of 38% over the same period. This translates to an average annual gain of 25% per year which coincidently is the target I set in my book (published years ago and now out of print).

Table 1: Mike’s Annual Blog Stock Pick Performance (5 Years)

Unlike last year, I certainly cannot take a victory lap for my 10 forecasts as I missed on 3 of the 10 and barely beat the S&P for my average among my 4 stock picks (all of which will be included again in my 2019 top ten). I’ve listed in bold each of my 2018 stock picks and trend forecasts below and give a personal, and only modestly biased, evaluation of how I fared on each.

  1. Tesla stock appreciation will continue to outpace the market (it opened the year at $312/share)

Tesla had an extraordinary Q3, 2018 as the model 3 launch showed how potent a player the company is becoming. In the quarter the Model 3 was the best selling car in the U.S. in terms of revenue and 5th highest by volume. This drove a greater than 100% revenue increase versus a year earlier and $1.75 in earnings per share versus a loss of $4.22 in the prior quarter. Given that the starting price for a model 3 was at $49,000, it is rather amazing that it could generate that volume of sales. Since the backlog for the Model 3 appears to remain at well over 300,000 cars and Tesla is closing in on a launch in Europe, Tesla seems assured of continued strong revenue through 2019 and likely beyond. However, much of the backlog is awaiting the lower priced (sub $40,000) version of the car which I believe will be available in Q2, 2019. As I had predicted, the Model 3 ramp up in production volume led to improved gross margins which exceeded 20% in the quarter. Despite the down market, Tesla stock was up about 7% in 2018. While we will continue recommending the stock, the phaseout of tax credits for buying an electric car has already begun. In its Q3 update Tesla stated that “better than expected Model 3 cost reductions is allowing us to bring more affordable options to the market sooner.” Yet, despite this forecast, the recently announced price decreases drove the stock down.

  1. Facebook stock appreciation will continue to outpace the market (it opened the year at $182/share).

Facebook stock did not perform well in 2018, closing the year down 28%, making this pick a losing proposition last year. This comes despite revenue growth that should be between 35% and 40%, and net income that is tracking towards about 35% growth (despite a massive increase in SG&A to spur future results).  What impacted the stock heavily was the plethora of criticism regarding privacy of user information coupled with the continuing charges of Russian usage to impact the election. Before the wave after wave of negative publicity the stock had reached a new high of $218/share in July. Because of the need to improve its reputation, Facebook is likely to continue to increase its spending to address privacy issues and to burnish its image. In summary, the fundamentals of the company remained quite sound in 2018 but the barrage of issues torpedoed the stock.

  1. Amazon stock appreciation will outpace the market (it opened the year at $1188/share).

While its stock dropped considerably from its September high of $2050, Amazon remained one of the best market performers in 2018 closing the year at over $1500/share. The company continued to execute well, growing every part of its business. It also began to leverage its scale as net income grew considerably faster than revenue and is likely to be well over triple that of 2017. Growth should be lower in Q4 2018 than earlier in the year as Q4 2017 was the first quarter that included all revenue from the acquisition of Whole Foods. Since the analyst consensus forecast already reflects Whole Foods revenue being in Q4 last year, as well as concerns over Amazon maintaining strong performance in Q4, I would not be surprised if Amazon was able to beat expectations in Q4.

  1. Stitch Fix stock appreciation will outpace the market (it opened the year at $25/share).

In my forecast I stated that this was my riskiest pick and it certainly proved the most volatile (which is saying a lot given the turbulence experience by Facebook, Tesla, and Amazon). I was feeling pretty smug when the stock reached a high of $52/share in September with a little over 3 months left in the year! Obviously, I was less sanguine as it dropped precipitously from September’s high to a low point of $17.09 by year’s end. I’m hoping that those of you who followed my advice trimmed back when the stock soared (I confess that I didn’t). The company continued to balance growth and profitability throughout the calendar year with October quarter revenue (up 24%) and earnings ($10.7 million up from $1.3 million in the prior year) both beating analyst expectations. Yet, concerns over user growth severely impacted the stock. I’m somewhat surprised by this as the users grew 22% and revenue 24% – since revenue beat expectations this means that analysts did not forecast an increase in average revenue per user. But the bottom line is, despite solid fundamentals the stock did not perform well.

  1. The stock market will rise in 2018 (the S&P opened the year at 2,696 on January 2).

When I made this forecast, I pointed out that I’m not particularly good at forecasting the overall market. My belief was based on the fact that the tax cut for corporations would mean a rise in earnings that exceeded the norm. I felt stronger earnings growth would be enough to offset the risk of the longest bull market in history turning negative. I sited the likelihood of higher interest rates being an additional risk. The market almost made it through the year as it was still up heading into December, but the combination of 4 interest rate hikes in the year coupled with considerable criticism of President Trumps behavior was just too much for the market by December. I view this as a partial victory as I had all the fundamentals right and came within less than a month of being right for the year when many felt the bears would gain control in early 2018.

  1. Battles between the federal government and states will continue over marijuana use but the cannabis industry will emerge as one to invest in.

During the year the legalization of marijuana for recreational use continued to increase on a state by state basis with the number increasing from 6 at the start of the year to 10 by years end. Use of medical marijuana is now legal in 33 states. Several other states, while not formally legalizing it have lowered restrictions on individual use. The industry remains at a very early stage, but numerous companies are now public, and the recent market correction has the shares of most of these at more reasonable levels. While I would urge great care in stock selection, it appears that the industry has emerged as one to consider investing in.

  1. At least one city will announce a new approach to urban transport.

In this prediction I cited the likelihood that at least one city would commit to testing a system of small footprint automated cars on a dedicated route (as discussed in our post on December 14, 2017) as this appears to be a more cost effective solution than rail, bus, Uber, etc. Kyoto has now announced that it signed an agreement to test the system offered by Wayfarer and the company is now out of stealth mode. Wayfarer expects to provide substantial capacity at a fraction of the cost of other alternatives: both in the initial cost of the infrastructure/equipment and the annual cost of running the system. Of course, once there is a live installation in Kyoto or one of their other prospective customers, the validity of this system will be authenticated (or not).

  1. Offline retailers will increase the velocity of moving towards omnichannel.

This forecast discussed both acquisitions of e-commerce companies by offline retailers (with Walmart leading the way) and introducing more online technology in physical stores. Walmart did continue its online buying spree in 2018 with major acquisitions of Art.com, Bare Necessities, Eloquii, Cornershop and Flipkart (the largest at $16 billion). In the case of the acquisitions that are online brands, Walmart intends to introduce these into their physical stores and continue to sell them online. Nordstrom has also moved further to integrate its online and offline business by taking valuable floor space in stores and repurposing it for online buyers to pick up and try on clothes they have purchased online. By placing the location in a very prominent spot, I’m sure Nordstrom is thinking it will help spur more customers to buy online. By having in store locations for picking up and trying on, Nordstrom should reduce returns, lower the cost of shipping, and bring additional customers into their stores (who otherwise might not visit them).

  1. Social Commerce will begin to emerge as a new category

Recall that social commerce involves the integration of social media with commerce through tactics like:

  1. A feed-based user experience
  2. Having friends’ actions impact one’s feed
  3. Following trend setters to see what they are buying, wearing, and/or favoring
  4. One click to buy

Now, about 25% – 30% of shoppers say that social platforms like Pinterest, Instagram, Facebook and Snapchat have influence over their purchases. On June 28, 2018 Snapchat began a program for its influencers to use Social Commerce through a tool that allows users to view a video from the influencer and then to swipe up on a product shown in the video to buy it. In September, The Verge reported that Instagram is developing a new app for social commerce. Pinterest and Facebook have been in the social commerce fray longer and have increasing success. It appears that 2018 was the year the social commerce wars accelerated.

  1. “The Empire Strikes Back”: automobile manufacturers will begin to take steps to reclaim use of its GPS.

Carmakers face a serious problem regarding their built-in navigation systems. Consumers are forced to pay hundreds of dollars for them and then use free apps on their phones like Waze or Google maps instead. This does not endear them to consumers. The problem is that carmakers are not great at software design but have been reluctant to use third party providers for their GPS and entertainment. Now, the Renault-Nissan-Mitsubishi Alliance has agreed to design Google’s Android OS, including Google navigation, into their next generation cars expected starting in 2021. This is a win for users as that will provide a competent GPS that utilizes the existing screen in cars as opposed to having to rely on your phone app for navigation.

In another win for consumers, Amazon and Telenav (a connected car and location based services provider) announced a significant partnership today, January 7, 2019. As part of it, Amazon’s voice assistant will now be part of Telenavs in-car navigation systems. With this included, Telenav’s next generation system will enable its customers, like General Motors, to provide a “smart assistant” thereby making the system included with cars the one to use rather than one’s phone apps.

Stay tuned for my top ten predictions for 2019…but remember that I have already said the 4 stocks recommended for 2018 will remain on the list.

Interesting KPIs (Key Performance Indicators) for a Subscription Company

Mike Kwatinetz Ecommerce, KPI, Predictions, Startups, Stocks, Technology , , , , ,

what-are-key-performance-indicators-kpis

In working with early stage businesses, I often get the question as to what metrics should management and the board use to help understand a company’s progress. It is important for every company to establish a set of consistent KPIs that are used to objectively track progress. While these need to be a part of each board package, it is even more important for the executive team to utilize this for managing their company. While this post focuses on SaaS/Subscription companies, the majority of it applies to most other types of businesses.

Areas KPIs Should Cover

  1. P&L Trends
  2. MRR (Monthly Recurring Revenue) and LTR (Lifetime Revenue)
  3. CAC (Cost of Customer Acquisition)
    1. Marketing to create leads
    2. Customers acquired electronically
    3. Customers acquired using sales professionals
  4. Gross Margin and LTV (Life Time Value of a customer)
  5. Marketing Efficiency

Many companies will also need KPIs regarding inventory in addition to the ones above.

While there may be very complex analysis behind some of these numbers, it’s important to try to keep KPIs to 2-5 pages of a board package. Use of the right KPIs will give a solid, objective, consistent top-down view of the company’s progress. The P&L portion of the package is obviously critical, but I have a possibly unique view on how this should be included in the body of a board package.

P&L Trends: Less is More

One mistake many companies make is confusing detail with better analysis. I often see models that have 50-100 line items for expenses and show this by month for 3 or more years out… but show one or no years of history. What this does is waste a great deal of time on predicting things that are inconsequential and controllable (by month), while eliminating all perspective. Things like seasonality are lost if one is unable to view 3 years of revenue at a time without scrolling from page to page. Of course, for the current year’s budget it is appropriate for management to establish monthly expectations in detail, but for any long-term planning, success revolves around revenue, gross margins, marketing/sales spend and the number of employees. For some companies that are deep technology players there may be significant costs in R&D other than payroll, but this is the exception. By using a simple formula for G&A based on the number of employees, the board can apply a sanity check on whether cost estimates in the long-term model will be on target assuming revenue is on target. So why spend excessive time on nits? Aggregating cost frees up time for better understanding how and why revenue will ramp, the relationship between revenue types and gross margin, the cost of acquiring a customer, the lifetime value of a customer and the average spend per employee.

In a similar way, the board is well served by viewing a simple P&L by quarter for 2 prior years plus the current one (with a forecast of remaining quarters). The lines could be:

Table1: P&L by Quarter

A second version of the P&L should be produced for budget comparison purposes. It should have the same rows but have the columns be current period actual, current period budget, year to date (YTD) actual, year to date budget, current full year forecast, budget for the full year.

Table 2: P&L Actual / Budget Comparison

Tracking MRR and LTR

For any SaaS/Subscription company (I’ll simply refer to this as SaaS going forward) MRR growth is the lifeblood of the company with two caveats: excessive churn makes MRR less valuable and excessive cost in growing MRR also leads to deceptive prosperity. More about that further on. MRR should be viewed on a rolling basis. It can be done by quarter for the board but by month for the management team. Doing it by quarter for the board enables seeing a 3-year trend on one page and gives the board sufficient perspective for oversight. Management needs to track this monthly to better manage the business. A relatively simple set of KPIs for each of 12 quarterly periods would be:

Table 3: MRR and Retention

Calculating Life Time Revenue through Cohort Analysis

The detailed method of calculating LTR does not need to be shown in every board package but should be included at least once per year, but calculated monthly for management.

The LTR calculation uses a grid where the columns would be the various Quarterly cohorts, that is all customers that first purchased that quarter (management might also do this using monthly instead of quarterly). This analysis can be applied to non-SaaS companies as well as SaaS entities. The first row would be the number of customers in the cohort. The next row would be the first month’s revenue for the cohort, the next the second months revenue, and so on until reaching 36 months (or whatever number the board prefers for B2B…I prefer 60 months). The next row would be the total for the full period and the final row would be the average Lifetime Revenue, LTR, per member of the cohort.

Table 4: Customer Lifetime Revenue

A second table would replicate the grid but show average per member of the cohort for each month (row). That table allows comparisons of cohorts to see if the average revenue of a newer cohort is getting better or worse than older ones for month 2 or month 6 or month 36, etc.

Table 5: Average Revenue per Cohort

Cohorts that have a full 36 months of data need to be at least 36 months old. What this means is that more recent cohorts will not have a full set of information but still can be used to see what trends have occurred. For example, is the second months average revenue for a current cohort much less than it was for a cohort one year ago? While newer cohorts do not have full sets of monthly revenue data, they still are very relevant in calculating more recent LTR. This can be done by using average monthly declines in sequential months and applying them to cohorts with fewer months of data.

Customer Acquisition Cost (CAC)

Calculating CAC is done in a variety of ways and is quite different for customers acquired electronically versus those obtained by a sales force.  Many companies I’ve seen have a combination of the two.

Marketing used to generate leads should always be considered part of CAC. The marketing cost in a month first is divided by the number of leads to generate a cost/lead. The next step is to estimate the conversion rate of leads to customers. A simple table would be as follows:

Table 6: Customer Acquisition Costs

table 6.1

For an eCommerce company, the additional cost to convert might be one free month of product or a heavily subsidized price for the first month. If the customer is getting the item before becoming a regular paying customer than the CAC would be:

CAC = MCTC / the percent that converts from the promotional trial to a paying customer.

CAC when a Sales Force is Involved

For many eCommerce companies and B2B companies that sell electronically, marketing is the primary cost involved in acquiring a paying customer. For those utilizing a sales force, the marketing expense plus the sales expense must be accumulated to determine CAC.

Typically, what this means is steps 1 through 3 above would still be used to determine CPL, but step 1 above might include marketing personnel used to generate leads plus external marketing spend:

  1. CPL (cost per lead) as above
  2. Sales Cost = current month’s cost of the sales force including T&E
  3. New Customers in the month = NC
  4. Conversion Rate to Customer = NC/number of leads= Y%
  5. CAC = CPL/Y% + (Sales Cost)/NC

There are many nuances ignored in the simple method shown. For example, some leads may take many months to close. Some may go through a pilot before closing. Therefore, there are more sophisticated methods of calculating CAC but using this method would begin the process of understanding an important indicator of efficiency of customer acquisition.

Gross Margin (GM) is a Critical Part of the Equation

While revenue is obviously an important measure of success, not all revenue is the same. Revenue that generates 90% gross margin is a lot more valuable per dollar than revenue that generates 15% gross margin. When measuring a company’s potential for future success it’s important to understand what level of revenue is required to reach profitability. A first step is understanding how gross margin may evolve. When a business scales there are many opportunities to improve margins:

  • Larger volumes may lead to larger discounts from suppliers
  • Larger volumes for products that are software/content may lower the hosting cost as a percent of revenue
  • Shipping to a larger number of customers may allow opening additional distribution centers (DCs) to facilitate serving customers from a DC closer to their location lowering shipping cost
  • Larger volumes may mean improved efficiency in the warehouse. For example, it may make more automation cost effective

When forecasting gross margin, it is important to be cautious in predicting some of these savings. The board should question radical changes in GM in the forecast. Certain efficiencies should be seen in a quarterly trend, and a marked improvement from the trend needs to be justified. The more significant jump in GM from a second DC can be calculated by looking at the change in shipping rates for customers that will be serviced from the new DC vs what rates are for these customers from the existing one.

Calculating LTV (Lifetime Value)

Gross Margin, by itself may be off as a measure of variable profits of a customer. If payment is by credit card, then the credit card cost per customer is part of variable costs. Some companies do not include shipping charges as part of cost of goods, but they should always be part of variable cost. Customer service cost is typically another cost that rises in proportion to the number of customers. So:

Variable cost = Cost of Goods sold plus any cost that varies directly with sales

Variable Profit = Revenue – Variable Cost

Variable Profit% (VP%) = (Variable Profit)/Revenue

LTV = LTR x VP%

The calculation of VP% should be based on current numbers as they will apply going forward. Determining a company’s marketing efficiency requires comparing LTV to the cost of customer acquisition. As mentioned earlier in the post, if the CAC is too large a proportion of LTV, a company may be showing deceptive (profitless) growth. So, the next set of KPIs address marketing efficiency.

Marketing Efficiency

It does not make sense to invest in an inefficient company as they will burn through capital at a rapid rate and will find it difficult to become profitable. A key measure of efficiency is the relationship between LTV and CAC or LTV/CAC. Essentially this is how many dollars of variable profit the company will make for every dollar it spends on marketing and sales. A ratio of 5 or more usually means the company is efficient. The period used for calculating LTR will influence this number. Since churn tends to be much lower for B2B companies, 5 years is often used to calculate LTR and LTV. But, using 5 years means waiting longer to receive resulting profits and can obscure cash flow implications of slower recovery of CAC. So, a second metric important to understand burn is how long it takes to recover CAC:

CAC Recovery Time = number of months until variable profit equals the CAC

The longer the CAC recovery time, the more capital required to finance growth. Of course, existing customers are also contributing to the month’s revenue alongside new customers. So, another interesting KPI is contribution margin which measures the current state of balance between marketing/sales and Variable Profits:

Contribution Margin = Variable Profits – Sales and Marketing Cost

Early on this number will be negative as there aren’t enough older customers to cover the investment in new ones. But eventually the contribution margin in a month needs to turn positive. To reach profitability it needs to exceed all other costs of the business (G&A, R&D, etc.). By reducing a month’s marketing cost, a company can improve contribution margin that month at the expense of sequential growth… which is why this is a balancing act.

I realize this post is long but wanted to include a substantial portion of KPIs in one post. However, I’ll leave more detailed measurement of sales force productivity and deeper analysis of several of the KPIs discussed here for one or more future posts.

Soundbytes

I’ll begin by apologizing for a midyear brag, but I always tell others to enjoy success and therefore am about to do that myself. In my top ten predictions for 2018 I included a market prediction and 4 stock predictions. I was feeling pretty good that they were all working well when I started to create this post. However, the stock prices for high growth stocks can experience serious shifts in very short periods. Facebook and Tesla both had (what I consider) minor shortfalls against expectations in the 10 days since and have subsequently declined quite a bit in that period. But given the strength of my other two recommendations, Amazon and Stitchfix, the four still have an average gain of 15% as of July 27. Since I’ve only felt comfortable predicting the market when it was easy (after 9/11 and after the 2008 mortgage blowup), I was nervous about predicting the S&P would be up this year as it was a closer call and was somewhat controversial given the length of the bull market prior to this year. But it seemed obvious that the new tax law would be very positive for corporate earnings. So, I thought the S&P would be up despite the likelihood of rising interest rates. So far, it is ahead 4.4% year to date driven by stronger earnings. Since I always fear that my record of annual wins can’t continue I wanted to take a midyear victory lap just in case everything collapses in the second half of the year (which I don’t expect but always fear). So I continue to hold all 4 stocks and in fact bought a bit more Facebook today.

Ten Predictions for 2018

Mike Kwatinetz Ecommerce, Marketing, Metrics, Predictions, Stocks, Technology , , ,

In my recap of 2017 predictions I pointed out how boring my stock predictions have been with Tesla and Facebook on my list every year since 2013 and Amazon on for two of the past three years. But what I learned on Wall Street is that sticking with companies that have strong competitive advantages in a potentially mega-sized market can create great performance over time (assuming one is correct)! So here we go again, because as stated in my January 5 post, I am again including Tesla, Facebook and Amazon in my Top ten list for 2018. I believe they each continue to offer strong upside, as explained below. I’m also adding a younger company, with a modest market cap, thus more potential upside coupled with more risk. The company is Stitch Fix, an early leader in providing women with the ability to shop for fashion-forward clothes at home. My belief in the four companies is backed up by my having an equity position in each of them.

I’m expecting the four stocks to outperform the market. So, in a steeply declining market, out-performance might occur with the stock itself being down (but less than the market). Having mentioned the possibility of a down market, I’m predicting the market will rise this year. This is a bit scary for me, as predicting the market as a whole is not my specialty.

We’ll start with the stock picks (with January 2 opening prices of stocks shown in parenthesis) and then move on to the remainder of my 10 predictions.

1. Tesla stock appreciation will continue to outpace the market (it opened the year at $312/share).

The good news and bad news on Tesla is the delays in production of the Model 3. The good part is that we can still look forward to massive increases in the number of cars the company sells once Tesla gets production ramping (I estimate the Model 3 backlog is well in excess of 500,000 units going into 2018 and demand appears to be growing). In 2017, Tesla shipped between 80,000 and 100,000 vehicles with revenue up 30% in Q3 without help from the model 3. If the company is successful at ramping capacity (and acquiring needed parts), it expects to reach a production rate of 5,000 cars per week by the end of Q1 and 10,000 by the end of the year. That could mean that the number of units produced in Q4 2018 will be more than four times that sold in Q4 2017 (with revenue about 2.0-2.5x due to the Model 3 being a lower priced car). Additionally, while it is modest compared to revenue from selling autos, the company appears to be the leader in battery production. It recently announced the largest battery deal ever, a $50 million contract (now completed on time) to supply what is essentially a massive backup battery complex for energy to Southern Australia. While this type of project is unlikely to be a major portion of revenue in the near term, it can add to Tesla’s growth rate and profitability.

2. Facebook stock appreciation will continue to outpace the market (it opened the year at $182/share).

The core Facebook user base growth has slowed considerably but Facebook has a product portfolio that includes Instagram, WhatsApp and Oculus. This gives Facebook multiple opportunities for revenue growth: Improve the revenue per DAU (daily active user) on Facebook itself; increase efforts to monetize Instagram and WhatsApp in more meaningful ways; and build the install base of Oculus. Facebook advertising rates have been increasing steadily as more mainstream companies shift budget from traditional advertising to Facebook, especially in view of declining TV viewership coupled with increased use of DVRs (allowing viewers to skip ads). Higher advertising rates, combined with modest growth in DAUs, should lead to continued strong revenue growth. And while the Oculus product did not get out of the gate as fast as expected, it began picking up steam in Q3 2017 after Facebook reduced prices. At 210,000 units for the quarter it may have contributed up to 5% of Q3 revenue. The wild card here is if a “killer app” (a software application that becomes a must have) launches that is only available on the Oculus, sales of Oculus could jump substantially in a short time.

3. Amazon stock appreciation will outpace the market (it opened the year at $1188/share).

Amazon, remarkably, increased its revenue growth rate in 2017 as compared to 2016. This is unusual for companies of this size. In 2018, we expect online to continue to pick up share in retail and Amazon to gain more share of online. The acquisition of Whole Foods will add approximately $4B per quarter in revenue, boosting year/year revenue growth of Amazon an additional 9%-11% per quarter, if Whole Foods revenue remains flattish. If Amazon achieves organic growth of 25% (in Q3 it was 29% so that would be a drop) in 2018, this would put the 3 quarters starting in Q4 2017 at about 35% growth. While we do expect Amazon to boost Whole Foods revenue, that is not required to reach those levels. In Q4 2018, reported revenue will return to organic growth levels. The Amazon story also features two other important growth drivers. First, I expect the Echo to have another substantial growth year and continue to emerge as a new platform in the home. Additionally, Amazon appears poised to benefit from continued business migration to the cloud coupled with increased market share and higher average revenue per cloud customer. This will be driven by modest price increases and introduction of more services as part of its cloud offering. The success of the Amazon Echo with industry leading voice technology should continue to provide another boost to Amazon’s revenue. Additionally, having a large footprint of physical stores will allow Amazon to increase distribution of many products.

4. Stitch Fix stock appreciation will outpace the market (it opened the year at $25/share and is at the same level as I write this post).

Stitch Fix is my riskiest stock forecast. As a new public company, it has yet to establish a track record of performance that one can depend upon. On the other hand, it’s the early leader in a massive market that will increasingly move online, at-home shopping for fashion forward clothes. The number of people who prefer shopping at home to going to a physical store is on the increase. The type of goods they wish to buy expands every year. Now, clothing is becoming a new category on the rapid rise (it grew from 11% of overall clothing retail sales in 2011 to 19% in 2016). It is important for women buying this way to feel that the provider understands what they want and facilitates making it easy to obtain clothes they prefer. Stitch Fix uses substantial data analysis to personalize each box it sends a customer. The woman can try them on, keep (and pay for) those they like, and return the rest very easily.

5. The stock market will rise in 2018 (the S&P opened the year at 2,696 on January 2).

While I have been accurate on recommending individual stocks over a long period, I rarely believe that I understand what will happen to the overall market. Two prior exceptions were after 9/11 and after the 2008 mortgage crisis generated meltdown. I was correct both times but those seemed like easy calls. So, it is with great trepidation that I’m including this prediction as it is based on logic and I know the market does not always follow logic! To put it simply, the new tax bill is quite favorable to corporations and therefore should boost after-tax earnings. What larger corporations pay is often a blend of taxes on U.S. earnings and those on earnings in various countries outside the U.S. There can be numerous other factors as well. Companies like Microsoft have lower blended tax rates because much of R&D and corporate overhead is in the United States and several of its key products are sold out of a subsidiary in a low tax location, thereby lowering the portion of pre-tax earnings here. This and other factors (like tax benefits in fiscal 2017 from previous phone business losses) led to blended tax rates in fiscal 2015, 2016 and 2017 of 34%, 15% and 8%, respectively. Walmart, on the other hand, generated over 75% of its pre-tax earnings in the United States over the past three fiscal years, so their blended rate was over 30% in each of those years

Table 1: Walmart Blended Tax Rates 2015-2017

The degree to which any specific company’s pre-tax earnings mix changes between the United States and other countries is unpredictable to me, so I’m providing a table showing the impact on after-tax earnings growth for theoretical companies instead. Table 2 shows the impact of lowering the U.S. corporate from 35% to 21% on four example companies. To provide context, I show two companies growing pre-tax earnings by 10% and two companies by 30%. If blended tax rates didn’t change, EPS would grow by the same amount as pre-tax earnings. For Companies 1 and 3, Table 2 shows what the increase in earnings would be if their blended 2017 tax rate was 35% and 2018 shifts to 21%. For companies 2 and 4, Table 2 shows what the increase in earnings would be if the 2017 rate was 30% (Walmart’s blended rate the past three years) and the 2018 blended rate is 20%.

Table 2: Impact on After-Tax Earnings Growth

As you can see, companies that have the majority of 2018 pre-tax earnings subject to the full U.S. tax rate could experience EPS growth 15%-30% above their pre-tax earnings growth. On the other hand, if a company has a minimal amount of earnings in the U.S. (like the 5% of earnings Microsoft had in fiscal 2017), the benefit will be minimal. Whatever benefits do accrue will also boost cash, leading to potential investments that could help future earnings.  If companies that have maximum benefits from this have no decline in their P/E ratio, this would mean a substantial increase in their share price, thus the forecast of an up market. But as I learned on Wall Street, it’s important to sight risk. The biggest risks to this forecast are the expected rise in interest rates this year (which usually is negative for the market) and the fact that the market is already at all-time highs.

6. Battles between the federal government and states will continue over marijuana use but the cannabis industry will emerge as one to invest in.

The battle over legalization of Marijuana reached a turning point in 2017 as polls showed that over 60% of Americans now favor full legalization (as compared to 12% in 1969). Prior to 2000, only three states (California, Oregon and Maine) had made medical cannabis legal. Now 29 states have made it legal for medical use and six have legalized sale for recreational use. Given the swing in voter sentiment (and a need for additional sources of tax revenue), more states are moving towards legalization for recreational and medical purposes. This has put the “legal” marijuana industry on a torrid growth curve. In Colorado, one of the first states to broadly legalize use, revenue is over $1 billion per year and overall 2017 industry revenue is estimated at nearly $8 billion, up 20% year/year. Given expected legalization by more states and the ability to market product openly once it is legal, New Frontier Data predicts that industry revenue will more than triple by 2025. The industry is making a strong case that medical use has compelling results for a wide variety of illnesses and high margin, medical use is forecast to generate over 50% of the 2025 revenue. Given this backdrop, public cannabis companies have had very strong performance. Despite this, in 2016, VCs only invested about $49 million in the sector. We expect that number to escalate dramatically in 2017 through 2019. While public cannabis stocks are trading at nosebleed valuations, they could have continued strong performance as market share consolidates and more states (and Canada) head towards legalization. One caveat to this is that Federal law still makes marijuana use illegal and the Trump administration is adopting a more aggressive policy towards pursuing producers, even in states that have made use legal. The states that have legalized marijuana use are gearing up to battle the federal government.

7. At least one city will announce a new approach to Urban transport

Traffic congestion in cities continues to worsen. Our post on December 14, 2017 discussed a new approach to urban transportation, utilizing small footprint automated cars (one to two passengers, no trunk, no driver) in a dedicated corridor. This appears much more cost effective than a Rapid Bus Transit solution and far more affordable than new subway lines. As discussed in that post, Uber and other ride services increase traffic and don’t appear to be a solution. The thought that automating these vehicles will relieve pressure is overly optimistic. I expect at least one city to commit to testing the method discussed in the December post before the end of this year – it is unlikely to be a U.S. city. The approach outlined in that post is one of several that is likely to be tried over the coming years as new thinking is clearly needed to prevent the traffic congestion that makes cities less livable.

8. Offline retailers will increase the velocity of moving towards omnichannel.

Retailers will adopt more of a multi-pronged approach to increasing their participation in e-commerce. I expect this to include:

  • An increased pace of acquisition of e-commerce companies, technologies and brands with Walmart leading the way. Walmart and others need to participate more heavily in online as their core offline business continues to lose share to online. In 2017, Walmart made several large acquisitions and has emerged as the leader among large retailers in moving online. This, in turn, has helped its stock performance. After a stellar 12 months in which the stock was up over 40%, it finally exceeded its January 2015 high of $89 per share (it reached $101/share as we are finalizing the post). I expect Walmart and others in physical retail to make acquisitions that are meaningful in 2018 so as to speed up the transformation of their businesses to an omnichannel approach.
  • Collaborating to introduce more online/technology into their physical stores (which Amazon is likely to do in Whole Foods stores). This can take the form of screens in the stores to order online (a la William Sonoma), having online purchases shipped to your local store (already done by Nordstrom) and adding substantial ability to use technology to create personalized items right at the store, which would subsequently be produced and shipped by a partner.

9. Social commerce will begin to emerge as a new category.

Many e-commerce sites have added elements of social, and many social sites have begun trying to sell various products. But few of these have a fully integrated social approach to e-commerce. The elements of a social approach to e-commerce include:

  • A feed-based user experience
  • Friends’ actions impact your feed
  • Following trend setters to see what they are buying, wearing, and favoring
  • Notifications based on your likes and tastes
  • One click to buy
  • Following particular stores and/or friends

I expect to see existing e-commerce players adding more elements of social, existing social players improving their approach to commerce and a rising trend of emerging companies focused on fully integrated social commerce.

10. “The Empire Strikes Back”: automobile manufacturers will begin to take steps to reclaim use of its GPS.

It is almost shameful that automobile manufacturers, other than Tesla, have lost substantial usage of their onboard GPS systems as many people use their cell phones or a small device to run Google, Waze (owned by Google) or Garmin instead of the larger screen in their car. In the hundreds of times I’ve taken an Uber or Lyft, I’ve never seen the driver use their car’s system. To modernize their existing systems, manufacturers may need to license software from a third party. Several companies are offering next generation products that claim to replicate the optimization offered by Waze but also add new features that go beyond it like offering to order coffee and other items to enable the driver to stop at a nearby location and have the product prepaid and waiting for them. In addition to adding value to the user, this also leads to a lead-gen revenue opportunity. In 2018, I expect one or more auto manufacturers to commit to including a third-party product in one or more of their models.

Soundbytes

Tesla model 3 sample car generates huge buzz at Stanford Mall in Menlo Park California. This past weekend my wife and I experienced something we had not seen before – a substantial line of people waiting to check out a car, one of the first Model 3 cars seen live. We were walking through the Stanford Mall where Tesla has a “Guide Store” and came upon a line of about 60 people willing to wait a few hours to get to check out one of the two Model 3’s available for perusal in California (the other was in L.A.). An hour later we came back, and the line had grown to 80 people. To be clear, the car was not available for a test drive, only for seeing it, sitting in it, finding out more info, etc. Given the buzz involved, it seems to me that as other locations are given Model 3 cars to look at, the number of people ordering a Model 3 each week might increase faster than Tesla’s capacity to fulfill.

Re-cap of 2017 Top Ten Predictions

Mike Kwatinetz Ecommerce, Golden State Warriors, Metrics, Predictions, Stocks, Technology , , , , ,

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.

  1. 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.
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. 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.
  7. 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.
  8. 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.
  9. 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.
  10. 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).