The market dropped about two percent in late Friday trading after reports that the U.S. government believes a Russian invasion of Ukraine is imminent. Was this reaction justified? Does this matter, one way or the other? (To US equity investors, not to the Ukrainians, we assume it matters to them.)
It’s really a question about investing with uncertainty. When the economy is humming along, companies are doing well, and the environment is stable, volatility decreases, and valuations expand. Visibility is great! Analysts can happily value companies based on earnings many years into the future without fear. However, this is an illusion. The future is inherently uncertain. Putin’s Ukrainian chess match is a reminder, not a change.
We are Reminded of Another Surprising Geopolitical Event: Brexit
We were attending an investment conference in Vail, CO when the news came through that the UK had voted to leave the EU. One attendee from England at the event squirmed in his seat as the group digested the unexpected result. On CNBC, a tele-journalist interviewed an articulate London-based analyst who broke down the dire situation using complex sentence structures and five-syllable words (surely an Oxbridge man!). He concluded by warning of Brexit’s enormous “fat tail risk” that could not be quantified. We recall it as a speech as frightening as it was devoid of any meaning. Nevertheless, the talk was memorable as captured the spirit of the moment, which manifested in a $2 Trillion loss in global equity market values the following day. The market had priced in this “new” uncertainty.
For a brief period, it was the end of days. Our clients called us, explaining how the entire European Union would unwind and the common currency would implode. Obama felt the need to call the British Prime Minister to reassure that the “special relationship” between the U.S. and the U.K. would survive the Brexit vote. But gradually, reality dawned that Brexit was just a giant and costly multi-year administrative headache.
Figure 1: It seemed like a big deal at the time: Ten year for the S&P500. Can you spot the Brexit panic in June 2016?
Is a Ukraine war more like Brexit or more like – something much worse? Honestly, we have no idea. We expect the market’s near-term focus on this uncertainty to contribute to increased volatility and lower stock prices, but the reality is that overall uncertainty has not really changed. Only the perception of uncertainty has become more acute.
It’s simple and there’s a mechanism in place for investors to react to surprising news. It’s called hitting the buy or sell button. It’s much more difficult and there’s no quick solution to estimate how an unexpected event changes a company’s long-term outlook for earnings and cash flow. As long-term investors, our job is to focus on the latter, and endeavor to avoid the former. When we think specifically about Ukraine, Russia’s objectives, and unintended consequences, the potential long-term impact on the demand for Domino’s pizzas, Nike sneakers, or Microsoft operating systems, among other businesses we own, all seems limited.
Selected Investment from Client Portfolios: Meta Platforms, aka Facebook (FB)
Facebook shares are more than 40% off a 52-week high. FB, or Meta, as it prefers itself to be known nowadays, upset investors by lowering its revenue targets and outlining several headwinds including increased competition, challenges related to Apple’s new IOS operating system (FB’s messaging on this has gone back and forth), and a shift in usage to video, which generates less revenue. The company also plans to continue investing billions in the Metaverse, which is not expected to show a profit for several years, assuming it becomes a thing at all.
We have owned (FB) in client accounts since inception (8/20/18) and have been buying it all the way up. We continue to buy the stock following the heartbreaker quarter. Here’s how we’re viewing this. The reason to own FB shares is that the company has nearly two billion people using its platforms (Facebook, Instagram, WhatsApp) daily. It has nearly three billion who login monthly. These users are freely giving FB huge amounts of personal data. FB is still in the early stages, in our opinion, of monetizing the unparalleled success of its offering. The long-term growth and cash flow potential must be massive.
As far as the Metaverse goes, we are not really believers. We are willing to go along for the ride with Zuckerberg on this, however, because he’s a proven visionary, and we’re not. If anyone is going to win the Metaverse, whatever that might mean, it will be Facebook and Zuckerberg, of that we feel confident.
Meanwhile, FB’s shares are as cheap as they have ever been. The stock has only traded near current valuation multiples (15x P/E and 8x EV/ EBITDA vs. 2023 forecasts) on three previous occasions. One of these was after the IPO and another was during the depths of the Covid-panic. Considering the company’s profit margins (EBITDA) of 45%, which means that FB is converting nearly half of each dollar of revenue into cash flow, its free cash generation, financial returns, and capital allocation (share repurchase of $45B last year is equal to more than 7% of the current market value), we believe these valuations would be attractive even if the company offered no growth, which is surely not the case.
Figure 2: Not so Meta: Meta Platforms (FB) three-year chart. We’ll be shocked if the stock is not much higher a few years from now.
Recent media citations and appearances: We recently spoke about Starbucks (SBUX) on Yahoo Finance TV. You can watch the interview by clicking here. We were also recently quoted in two stories on Luckin Coffee (LKNCY) which was the subject of an investment presentation we gave at the start of February at the ValueX Klosters investment conference, in Klosters, Switzerland. The stories about Luckin in the Wall Street Journal and the Financial Times, are behind paywalls. If you have subscriptions, the best way to read the stories is through their sites. If you don’t, we’ve linked PDF copies (which lose some of the fancy formatting) for the WSJ article Luckin Coffee, Waylaid by Fraud, Tries to Perk Back Up and the FT article Luckin Coffee, Can China’s Starbucks Win Back Investors. Enjoy.
Yours,
John Zolidis
President & Founder
Quo Vadis Capital, Inc.
John.zolidis@quovadiscapital.com
Mr. Zolidis founded Quo Vadis Capital, Inc., a Registered Investment Advisor (RIA) and research consultancy, in 2017. He started his career in finance in 1996 following degree studies in Philosophy at Kenyon College and the University of Oxford. He has followed U.S. consumer companies as a senior analyst since 1999, mostly on the sell-side, writing research for institutional investor clients. He also managed money in a buy-side role at a long-short equity fund over 2013-2014. He was named in the Wall Street Journal’s Best on the Street list in 2005. Mr. Zolidis and works from New York, NY and Paris, France or wherever he has his laptop.
