Eric Clark

June 7, 2023

In the Real World, We Love When Great Merchandise Goes on Sale. In the Investment World, Sales Can Offer Money-Making Opportunities.

Eric Clark

June 7, 2023

Key Points

Over the long-term, Tech and Consumer Discretionary are two sectors to anchor to.
2022 was a major “reset year” for stocks in general and tech & consumer in particular.
In 2023 – tech and consumer are winning again, but there’s still plenty of opportunities.

20 Years of Annualized Returns: Tech & Consumer Discretionary Outperform the S&P 500.

We know intuitively, buying great merchandise on sale is something consumers love. Ironically, in the investment business, when great stocks go on sale, investors tend to freeze or sell. That’s a mistake. Using short-term price direction as the mechanism to help make long-term investment decisions will often lead an investor astray. In this business, most funds, ETF’s or strategies tend to be anchored to a single or a few “style factors” or characteristics. Sometimes, the market favors strong top-line sales or high R&D spend, other times, the value factor is where returns are coming from. The important part of this story though: style factors go in and out of favor and the best opportunities come from understanding which factors, sectors, or thematics tend to work the best over longer periods of time. Once you understand this, 1) making sure you own the persistent winners is important and 2) being committed to adding to the LT winners when they experience the normal periods of underperformance offers a wonderful one-two punch to your long-term goal achievement plans. With that in mind, I thought I would investigate sector performance, short and long-term, to see if there’s any opportunities to seize.

20 years of data is a sufficient time frame, I think you would agree. For long-term investors, this is how the sector movie ends: Technology and Consumer Discretionary are the two key sector leaders over time. This shouldn’t be a surprise given these two sectors are key drivers of the global economy. Additionally, because of a recent sector shift by Index providers, a new sector, Communications Services has emerged. Many important tech & discretionary brands have been moved to the new Comm Services sector so I suspect this will also outperform over the long-term, particularly through names like: Meta (Facebook), Google, Netflix, Live Nation, and many more. Nothing happens every year but often, these two or three sectors and the high-quality brands that live here, should continue to perform well on an absolute and relative basis. Our research tells us most portfolios hold sufficient tech but not enough consumer exposure. Regardless, here’s the 20-year look across sectors.

Technology:

The tech sector performed very well versus all other sectors annualizing at ~14.1% over 20 years. This performance was generated by a handful of leading brands, however. Microsoft annualized at 16.5%, Apple at 38.2%, and Nvidia at 29.9% (source: YCharts). Important: the tech sector performed very poorly after the market peaked in March 2000. Some companies never recovered, but the leaders eventually began leading again. Those who understand buying great businesses on sale is smart and logical, got a chance to significantly beef-up their exposure to tech on mega-sale between 200-2003. When you know how the movie ends, you take advantage and buy more when the market acts irrationally.

Consumer Discretionary:

Not surprisingly, consumer stocks serving a strong consumer nation, also performed well annualizing at 10.5% over 20 years. A peek inside the index shows us again, a handful of great brands drove an even bigger portion of the gains in the sector. Stock selection really matters in consumer-land.

Amazon annualized at 23.4% over 20 years, Tractor Supply at 29.3%, Deckers Outdoors (owners of UGG and Hoka Shoes) at 31%, Booking Holdings at 26%, O’Reilly Automotive at 22.6%, and Dicks Sporting Goods at 17.1% per year.

My point is simple: When you know something has a history of performing well, 1) make sure you have an allocation to it for the long-term, and 2) when it experiences a period of underperformance, make sure you add to it while its down and so your speed to recovery is accelerated because of smart cost averaging strategies.

2022: The Great Re-set Year for Tech & Consumer Discretionary.

As you know, 2022 was a tough year for almost every asset class and style-factor. The growth and quality factors across equity-land performed particularly poorly. Why? Because interest rates went straight up for the entire year and multiples for growth stocks and sectors went down rapidly. That caused a ton of disruption across equities and fixed income. Ironically, business fundamentals were largely strong across the board, but the market did not care until late October. Many of the drawdowns in great businesses where irrational & illogical, and the opportunity created by buying more, was never in doubt. Over longer periods, the fundamentals always drive the bus. Here’s how 2022 looked at the sector level. Tech & Consumer Discretionary were the worst performers & Energy was the best performer. Great brands went on sale.

2023: A Mean Reversion via Tech & Consumer Discretionary Leadership.

Markets generally bottomed in mid-October last year and have largely trended higher into the recent month-end. You would never know it when you talk to investors, however. Massive amounts of money continue to go into money market funds, currently >$8 trillion. Only until recently and because of the AI FOMO, have investors decided to buy technology stocks. YTD, Technology and Consumer Discretionary are back on top and are the only sectors with positive returns thus far in 2023. Remember, many of the greatest brands live in the tech and consumer sectors so a brands-dedicated portfolio, by definition, will largely be anchored by tech and consumer stocks. Today’s market is incredibly bifurcated, though. The bulk of returns are coming from just a handful of great brands. As we started this year, the consensus thinking was for a continuing weak market into mid-year followed by a strong recovery. To date, the exact opposite is what has occurred. Consensus got it wrong again.

SUMMARY:

Over most periods since index creation in late 1989, tech and consumer discretionary stocks have tended to be outperformers.
Now you know how the movie ends. Now you know the answers to the test in advance.
When these important sectors go on sale, investors should begin adding more exposure.
Adding exposure to great brands and sectors on sale while they are experiencing temporary underperformance has historically been a very smart decision. Even after the current recovery, there are some very important, very dominant brands on sale.

Stay anchored to these two sectors for the long-term.

It’s not too late to pounce.

Buy/add on dips.

BRANDS MATTER

Disclosure:
The above report is a hypothetical illustration of the benefits of using a 3-pronged approach to portfolio management. The data is for illustrative purposes only and hindsight is a key driver of the analysis. The illustration is simply meant to highlight the potential value of building a consumption focused core portfolio using leading companies (brands) as the proxy investment for the consumption theme. This information was produced by Accuvest and the opinions expressed are those of the author as of the date of writing and are subject to change. Any research is based on the author’s proprietary research and analysis of global markets and investing. The information and/or analysis presented have been compiled or arrived at from sources believed to be reliable, however the author does not make any representation as their accuracy or completeness and does not accept liability for any loss arising from the use hereof. Some internally generated information may be considered theoretical in nature and is subject to inherent limitations associated therein. There are no material changes to the conditions, objectives or investment strategies of the model portfolios for the period portrayed. Any sectors or allocations referenced may or may not be represented in portfolios managed by the author, and do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that any investments in sectors and markets identified or described were or will be profitable. Investing entails risks, including possible loss of principal. The use of tools cannot guarantee performance. The charts depicted within this presentation are for illustrative purposes only and are not indicative of future performance. Past performance is no guarantee of future results.

Eric Clark

May 30, 2023

Consumer Spending on “Selective Indulgences” Remains Strong

Eric Clark

May 30, 2023

Key Points

Spending is in our DNA. Currently, our actions towards “safety” tell a story.
Consumers are making choices because they have been over-paying for everything.
Selective Indulgence is a key part of consumer spending; some brands are winning big.

Spending is in Our DNA

In last week’s blog, I noted Retail Sales recently hit a new record of $7 trillion over the trailing 12 months. Aggregate spending is a bit above the long-term trend, so we expect the spending dynamic to change as consumers continue to make important choices. As personal income goes positive as inflation cools over time, positive spending and saving dynamics will emerge. For now, consumers are a bit nervous about the current economy, the political uncertainty, and the potential for an economic slowdown. They are being bombarded with negative news stories which keeps them from wanting to take risks in places like the stock market. To highlight this, the chart below shows where consumers are putting their money so far this year.

Money market funds yielding ~4-5% hold about $7 trillion of our money today, which earns much more than our checking accounts. When consumers are nervous, holding more cash is always the first impulse and it makes us feel better. What I fear, they will stay in “safety” much longer than they should, which ultimately hurts their ability to generate the returns required to meet their long-term retirement goals. The best times to put our cash to work are the times when it feels the least attractive. That will never change. With markets performing much better than expectations, we suspect high net worth investors could begin to feel like they made a poor choice de-risking equities in Q4 last year. If the equity markets stay elevated, a FOMO effect could begin to build from those under-invested. FOMO happens when we are faced with falling behind in returns and feel compelled to chase equities, typically at the wrong time. The stats below show consumers have voted for safety for now. Equity outflows, safety asset inflows, and massive flows to money market funds is what has happened YTD. That tells me a lot as a contrarian investor.

Consumers Continue to Make Choices on Their Spending

Back to retail sales and the trends we see currently. We know with certainty that spending is in our collective DNA as a society. We are now beginning to see signs that consumers are not spending broadly but making important choices with their limited dollars. That will have implications for many businesses across a multitude of industries over the next 2 quarters. Last week, we talked about the mean reversion in spending and the parts of the goods economy that were still getting attention from a wallet-share perspective. The moral of the story: the spending was heavily skewed towards “needs versus discretionary wants.”

Selective Indulgence is a Key Focus for Those Willing to Spend Discretionary Dollars

Research firm McKinsey recently released an intriguing report discussing the state of the consumer entitled, “Overall consumer spending growth is slowing, but consumers still intend to splurge on select categories.” The authors cite the concept of selective indulgence as the key focus for spending. Our work also suggests things like travel, recreation, eating out, and live events are preferred areas of attention. Generally, younger consumers and higher-income consumers seem to be the most positive, with the middle consumer a bit more cautious. Thus far from an earnings perspective, there’s strong evidence of strength across travel and lodging brands as well as recreation categories and the ancillary goods and services that benefit from our recreation activities. That should remain resilient as we enter the summer vacation season.

It’s quite clear from earnings across the whole group of consumption categories, there’s trade-down activity happening broadly. Our take: consumers are saving money in some places so they can splurge in other places. That behavior does not scream we have a “super-bullish consumer” but it also doesn’t scream a, “super-bearish consumer.” That’s why our current portfolio is currently balanced by discretionary spending beneficiaries and needs-based spending beneficiaries. The recent BofA & J.P. Morgan consumer spending reports also confirmed consumers are making choices and they are balanced by needs and wants.

From an “intent to splurge” perspective, the chart below shows the spending categories most cited in the McKinsey report. Roughly 40% of respondents cited the intent to splurge in 2023. Their focus is cited below. Eating out and in, travel, recreation, out-of-home entertainment, and apparel and footwear were noted widely. What I found interesting though, was the intent to splurge on grocery being part of the results. Normally, grocery is a staple of life, so splurging is not generally associated with a staples of life. Again, I would call the results of the survey as encouraging but not wildly bullish for continued, above-trend spending.

What Looks Most Attractive in the Selective Indulgence Thematic?

Out of home entertainment:

One key area of focus is events and concerts. Live Nation is the dominant live events brand around the world. In their recent quarterly report, they cite, “for the first time in three years, all of our markets are fully open. Over 19 million fans attended our shows across 45 countries, and we sold over 145 million tickets with record levels of activity across all markets.” Simply put, the pent-up demand for live events and concerts is a key source for revenge spending around the world. LYV also cited “global demand for live events is unprecedented. Revenue was up 73% to $3.1 billion. We have sold 90+ million tickets YTD and demand shows no signs of easing thus far.” The stock has had a robust recovery off the lows but is still well-off all-time highs and arguably they have better pricing power, higher demand, and stronger sponsorship opportunities as brands all over the world begin allocating more to this business segment after being absent for 3 years. The ancillary goods and services around live events and travel should also perform well. Those include beer, wine and spirits, apparel merchandise, and overall food and beverages like Coke, Pepsi, and energy drinks.

Travel:

We are just beginning the summer travel season and virtually every part of the travel infrastructure is screaming the same thing: we are going on vacation and travelling to places like Vegas in droves. As our savings have been drawn down, we have been saving money over the last few months so we can spend more on our vacations. We will eat out, buy beauty products, buy snacks and beverages and likely shop for apparel & footwear while on vacation. The travel platforms like Booking, Expedia, Airbnb, and hotels like Marriot, Hyatt, and Hilton have all reported strong bookings while seeing consumers more interested in price discounts. Even airlines, some of the worst businesses in the world to run and invest in, are seeing record demand with lower airline fuel prices. For now, the “selective indulgence” trade is alive and well.

Disclosure:
This information was produced by Accuvest and the opinions expressed are those of the author as of the date of writing and are subject to change. Any research is based on the author’s proprietary research and analysis of global markets and investing. The information and/or analysis presented have been compiled or arrived at from sources believed to be reliable, however the author does not make any representation as their accuracy or completeness and does not accept liability for any loss arising from the use hereof. Some internally generated information may be considered theoretical in nature and is subject to inherent limitations associated therein. There are no material changes to the conditions, objectives or investment strategies of the model portfolios for the period portrayed. Any sectors or allocations referenced may or may not be represented in portfolios managed by the author, and do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that any investments in sectors and markets identified or described were or will be profitable. Investing entails risks, including possible loss of principal. The use of tools cannot guarantee performance. The charts depicted within this presentation are for illustrative purposes only and are not indicative of future performance. Past performance is no guarantee of future results.

Eric Clark

May 18, 2023

Consumer Spending is Mean Reverting Back to Long-Term Trend

Eric Clark

May 18, 2023

Key Points

U.S. Retail Sales has mean reverted to its long-term trend (as expected).
Because of high inflation and macro uncertainty, consumers are forced to make choices again.
Spending on “essentials” and “must-have” discretionary items is the focus for now.

Consumer Spending Has Been Robust and Has Mean Reverted Back to Trend

When consumers were locked in their homes and shopping online, savings rates and goods spending went parabolic. When things go parabolic, they should be expected to mean revert to the long-term trend over time. That’s exactly what has happened with Retail Sales and the components within this $7 trillion per year component of GDP. The entire COVID period is now normalizing from a spending perspective, but there will still be some ripples across different categories. Consumers over-spent on goods and durable items and under-spent on services and experiences. We see some fracturing of services spend around the edges currently, but this component of spending is still more stable and elevated relative to the goods spending that is soft as we enter summer vacation season.

As you can see from the chart below, retail sales went parabolic and have now steadily fallen back to an area where it tends to chop around. We are watching closely for continued weak spending, which could warrant more defensiveness in our positioning. With inflation across most services and food categories, we expect consumers to simply make choices about where to spend their money and time. Some items will be deferred while others get the benefit of our marginal discretionary dollar. Needs over wants is our focus, while also holding exposure to the most important wants, which include technology, travel, everyday fashion apparel & footwear, and entertainment.

Consumers Do Not Have Unlimited Spending Capacity; Choices Must Be Made

The bears will highlight the extreme fall of total credit and debit card spend, but one must remember the spending was extreme and always expected to mean revert down. Whether consumers retrench even more aggressively, only time will tell, but thus far we are seeing exactly what we expected in spending trends. This BofA spending chart from their May 2023 report highlights what’s been happening since the peak in Q1 2021. Remember, our savings ballooned and have also mean reverted to slightly below long-term averages, now about 4.6%. Savings are now being built up again as we get more nervous about the economy. BofA states, savings overall are still about 40% higher on average than the 2019 levels, so there is still a savings cushion for most consumers. Lots of data here for a bear or a bull which simply makes for more volatility around these numbers.

Digging deeper into consumer spending, the chart below highlights how consumers are making choices and where they are spending today. To reiterate, for now, it’s a “needs over wants” spending environment. The chart shows U.S. Retail Sales by component on a year-over-year basis. The focus continues to be experiences and “needs spending” across these areas: general merchandise (includes grocery), health & personal care, food & beverages, eating and drinking out, and nonstore retailers (e-commerce) over physical shopping. Traffic trends to physical stores has been slowing. With belts tighter from inflation, perhaps families are spending less in April, May, and maybe even half of June so they can have more fun and spend on vacation? Our family is certainly thinking that way.

As we look at stock performance, it’s clear for now, the defensive stocks are holding up well while many retailers and specialty retailers have pulled back. Based on our work, we could see one more quarter where retail sales trends get softer, which could offer much better entry points in some great retail stocks and even a few secondary brands that have gotten overly beaten up.

What Looks Attractive Now Across Positive Trending Categories?

General Merchandise:

Costco is still performing well, and the stock is off from the recent peak offering an opportunity. The management team at Costco are some of the best in the industry and as they see their costs fall from vendors, they pass along the savings to customers. That’s why the loyalty is so strong at Costco. They recently raised the dividend by 13%, which is better than most other consumer brands. Their business serves our general merchandise and grocery needs well so we expect stability in this great business model.

Health & Personal Care:

In last week’s blog, I highlighted a new edition to the portfolio in KenVue, the largest consumer healthcare brand by sales in the world. They own our medicine cabinet with brands like Band-Aid, Benadryl, Listerine, Pepcid, and Zyrtec for your seasonal allergies. If you haven’t read the report, click here to read it.

Food & Beverage:

Some of these brands have been monster performers for a long period of time and with consumers making choices and favoring needs, we still like these brands. Snacks are very important to consumers and Pepsi, through their house of brands that include Lay’s, Doritos, Ruffles, Tostitos, Sunchips, and Cheetos are doing quick well. In the most recent quarter, management cited strong volume trends with good pricing power and no pushbacks on price thus far. Hershey is performing well also and should benefit from falling input costs while prices remain higher. The stock is not cheap, but we see strong trends across this wonderful portfolio of brands. The traditional beverage business with Pepsi, Gatorade, Aquafina Water, 7Up, Starbucks Beverages, and its newest addition with the stake in emerging energy brand Celsius continue to do well. Similarly, Coke and its top beverage brands that include its partnership with Monster Beverage are performing well.

Food & Drinking Services:

Leading Brands like Starbucks, McDonald’s, Chipotle, Domino’s, and restaurants and bars are still performing well. So many of these brands, particularly local restaurants, have taken prices up significantly as workers were hard to find and expensive. I keep waiting for consumers to push back on price here but thus far, the top brands and our favorite restaurants are still performing well. Margin pressure could be a problem soon if consumers finally push back on their spending in this category.

E-Commerce:

Amazon is the 800 lb. gorilla in this category and we still think this stock has much further to run. It’s basically gone nowhere for a few years, yet revenues have ballooned. As their spending mean reverts closer to long-term averages, we expect the free cash flow line to vault higher once again. The stock is not currently priced for this eventuality in our opinion.

Next week, I’ll tackle the spending in services and which categories across travel and recreation still look attractive.

Eric Clark

May 2, 2023

Rotate in May and Go Play!

Eric Clark

May 2, 2023

Key Points

Sell in May and go away is the market narrative but it’s track record is spotty.
Getting more defensive with leading healthcare & staples brands seems to work better.
As the economy cools further, this strategy seems to have strong merit today.

Sell in May, Go Away?

As April ends and May begins, the drumbeat of “Sell in May and Go Away” grows louder and louder. It’s important to remember two things about this concept: 1) it does not work every year and 2) a better approach has typically been to “rotate to defensives” like healthcare and staples in May versus going away entirely. Every year is unique and there’s always earnings, macro, Fed policy, and geopolitics driving the narrative so making a 1-size fits all decision is likely to end with mixed results. This year, and much to the chagrin of bears, tech and consumer discretionary sectors have performed much better than expected. That tends to happen when bearish sentiment and positioning gets as extreme as it was in Q4 last year. Much of that bearish positioning has been rectified today and healthcare and staples have lagged thus far in 2023. We think that’s about to change as money begins to rotate to get more balance as it seeks more stable, predictable earnings. Time will tell, we certainly do not know the future better than anyone else but in today’s note, I thought it would be interesting to look back at other difficult market years to see how a blend of 3 leading healthcare and staples brands performed versus the S&P 500 and Nasdaq 100 in the May – October period. Very interesting results for people that think the economy gets softer from here as the Fed’s actions begin to filter through the system.

Rotating to healthcare & staples, “defensives”, has a terrific track record in tough periods.

Rather than use broad-based ETF’s as the proxy for this theme, I created an equal-weight 6 stock model portfolio using 3 leading healthcare brands across managed care, pharma, and life sciences & tools (UNH, LLY, TMO) and 3 leading consumer staples brands across general merchandise shopping, fast casual restaurants, and packaged foods (COST, MCD, HSY). I then compared the indices to this defensive, healthcare/staples basket while using SPY and QQQ as the proxy for the broad market. Generally, in positive trending bull markets, the defensive blend lags which we would expect, but in more difficult years, the defense basket generally shielded investors from bigger downside action in the indices. Additional brands that tend to be quite resilient in turbulent times include: Church & Dwight (CHD), Procter & Gamble (PG), Mondelez (MDLZ), Coca-Cola (KO), Pepsi (PEP).

Economic weakness just ahead could favor the defense basket.

Equities have generally performed better than expected thus far in 2023. Earnings beats are slowing, and breadth has been quite poor for the last few weeks. The mega-cap brands have largely done all the heavy lifting where YTD performance is concerned. Either the laggards need to begin performing or the leaders could join the laggards and provide further market weakness.

Only in time will we know what happens but here’s how the indices have performed versus the healthcare and staples blend in years with a recession or some idiosyncratic macro issues that caused some market dislocations The defensive blend is in blue.

2000-2002 Internet Bubble & Recession: Defensives Win Big Through the Entire Period.

2000-2002 May-November, 3 Periods: Internet Bubble & Recession: Defensives Did Their Job.

2008: Great Financial Crisis. Defensives Lose Much Less.

2011: Debt Ceiling Crisis & European Debt Issues. Defensives Win.

2018: Strong Market Until Fed Hikes Rates Into an Economic Slowdown: Defensives Win Big.

2022 Peak Market, Historic Rate Hikes, & 40 Year High Inflation: Defensives Win Big.

BOttom Line:

The market has performed fairly well YTD but we see some softening in prices as earnings & margins become the focus. Generally, defensive business models offer more stable & predictable earnings and dividends, which makes them very interesting in slowdowns. Additionally, capital tends to rotate to defensive sectors and businesses when volatility and uncertainty arises. Healthcare is a big laggard YTD after having a stellar 2022 and seems to be refreshed and ready to begin performing again. Using the ETF’s for healthcare and consumer staples seems fine but my work shows betting on a handful of leaders tends to enhance the experience. In former years where markets were volatile with a downward bias, the defensive basket of leading brands tended to either deliver a positive return or offered much less downside than the indices and other beta sectors.

Eric Clark

April 17, 2023

How to Play Offense & Defense in a Portfolio: Part 2 – Offense

Eric Clark

April 17, 2023

Key Points

A balanced portfolio holding companies that play offense & defense is key.
In the new economic regime, certain style factors make the most sense.
Top “offense-oriented” brands grow despite short-term economic slowing.

Balance in a portfolio can help offer a smoother ride to investors.

For Part 2 of the portfolio creation topic, I wanted to shift to offense. There’s thoughtful, steady growth while paying attention to costs and maintaining high operational efficiency and there’s growth at all-cost. When rates were at zero and access to capital was plentiful, the “growth-at-all-cost” companies performed exceptionally well. In today’s new regime of higher base rates cost of capital, and inflation, those companies are not where one should be focused, in our opinion. This week let’s focus on the “grow through a slowdown while running the business prudently” group of offense-minded brands.

As the Fed’s aggressive actions begin to take effect across markets and the economy, it’s important to remember that brands highly focused on offense tend to be growth-oriented businesses which also tend to be higher beta (more volatile than defensives generally) and could struggle in a slowdown as end-markets slow and revenue growth eases a bit. Secular growth, or mega-trends as we call them, tend to be more stable and long-lived and can sometimes be less sensitive to shorter-term slowdowns than other cyclical growth opportunities.

Remember, to oversimplify, this is generally what investors want when they make the decision to invest their capital for long-term growth. Knowing these end-goals helps build the most appropriate portfolio for investors:

Achieve attractive returns
Have as smooth a ride along the way as possible.
Reach their target goal on time and intact.

How they accomplish these three goals is where the magic happens. In many cases, it’s BALANCE that helps them experience a smooth ride. When the economy slows, the best companies and brands make important decisions about where to cut costs while also continuing to grow and take market share. In fact, the best brands tend to take market share in difficult periods because they think long-term, and they have strong balance sheets that enable them to spend through slowdowns.

Important style factors for the new investment regime.

Reminder: style factors describe the characteristics of a business. Most of the time, we tend to be overweight the “quality” style factor partly because it tends to outperform long-term and partly because top brands tend to be high quality companies relative to the stock universe.

From an offense and “prudent growth” perspective, there are a handful of metrics that we believe are important to focus on today. If you are a business owner, you will instantly appreciate the importance of these metrics: high free cash flow, high free cash flow growth, high return on invested capital (ROIC), fairly stable revenue growth over time, a steady reduction in the number of shares outstanding if possible, strong balance sheet, better margins than industry peers, reasonable valuations relative to the growth opportunities in front of them, high interest expense coverage so you can service debt easily, margin expansion possibilities, and positive EPS and revenue revisions. If you want to know why market returns tend to come from only a handful of companies, look no further than the rigid list of strong metrics I have listed above. Should anyone be surprised that the bulk of long-term market returns come from a much smaller number of companies that have superior business models, management, and global opportunities?

Quality, Stable Offense via Growth Brands

Generally, the companies that can continue to grow their revenue and free cash flow across multiple demographic groups, geographies, economic environments, and through new product innovations, tend to generate strong investment returns for shareholders. These are also the brands that tend to join the $trillion-dollar-club over time. Sometimes, these companies are called “compounders”, we call them Mega-Brands. Using real-time corporate data, here’s a few Mega Brands that seem well-positioned today, rank highly across the factors cited above, and should show some stability in an economic slowdown:

Visa (V) & Mastercard (MA): “Everywhere You Want to Be”.

The use of cash has been slowly falling all over the world. In emerging market economies, the trend of using cash over cards is more prevalent still, given a large segment of the emerging consumer population does not have a traditional bank account. However, there are tons of fin-tech brands building unique value propositions to help these consumers enter the “swipe over cash” thematic. Yet, two mega brands still dominate the payment processing industry, and they are wonderfully profitable businesses. Collectively, Visa and Mastercard process almost 85% of payment transaction in the U.S., the world’s largest economy. As the economy slows and consumers make choices where and how to spend, having less exposure to consumer credit issues is ideal. Unlike American Express, CapitalOne and others, Visa & Mastercard have very little credit risk embedded in their businesses.

Consider them the owner and partners in a vast global toll-road where every visitor must pay the toll. Roughly 70% of every revenue dollar falls directly to the free-cash-flow line of Visa/Mastercard. They score in the 99 & 100th percentile for high margins and in the top decile for free cash flow metrics & operating efficiencies. They are aggressive buyers of their own stock when the stocks underperform, as they did through Covid when cross-border travel was virtually shut-down. Being more aggressive with new buying when stocks are low is exactly the kind of behavior that tends to reward companies and investors over the long-term.

Fun fact: V/MA stock has handily outperformed the S&P 500 Index over the last 1, 5, 10 years and since both went public. Over the last 3 years, with Covid restrictions and cross-border travel issues present, the stocks have underperformed. In our opinion, both companies are undervalued and will beat expectations over the next 12 months as global travel normalizes and higher average inflation keeps average transaction value elevated.

Tesla: TSLA

Achieving scale is the key to maximizing efficiencies. Tesla has a huge lead over peers, and we think it’s sustainable for many years to come. As automation and robotics drive productivity and manufacturing gains, Tesla will continue to grow much faster than most companies, regardless of industry. Yes, Tesla could be the most polarizing brand ever created and the stock is neither cheap nor stable from day to day. Additionally, if we enter a true recession, their growth could slow a bit but it will rip right back once consumers feel better about the economy.

Aside from the love or hate of Tesla, hiding in plain sight is a massive secular growth trend that is still in its infancy: the electrification of everything, starting with vehicles.

To be clear, the major opportunity for Tesla shareholders was going from small production to major production.

That stage for Tesla is largely complete but when you look at the small overall EV adoption curve and its growth trajectory while combining Tesla’s manufacturing lead and its strong brand as THE innovator in the space, there’s more growth for the company and stock in my opinion. I have little doubt that Tesla will once again be part of the $trillion club. The global opportunity is simply too large and attractive. Oddly, the stock is still under-owned institutionally, yet it has some of the most robust growth metrics relative to other companies who play offense. Here’s a quick glance at Tesla’s metrics at fiscal-end 2017 versus fiscal-end 2022:

$11.8B in annual revenue.
$3.4B in total cash.
Model 3 deliveries were just beginning.
There was no Model Y yet.
1128 supercharging locations globally.
Automotive gross margins: 18.9%.

Here’s how fiscal 2022 ended for Tesla:

$81.4B in annual revenue.
$22.2B in cash with no debt – a monster achievement for any car company.
$7.56B in free cash flow generated.
Model 3 and Model Y scaled production has occurred.
~4200 supercharging locations globally.
Automotive gross margins: 25.9% – the best in the industry.

Tesla stock can be a wild ride at times given how polarizing Elon Musk is and how noisy the earnings releases can be quarter-to-quarter but keep your eye on the prize: global EV adoption. Volatile stocks like this should be sized accordingly in a portfolio but TSLA surely added some value to a portfolio as they reached global scale.

A $10,000 investment in July 2010 would be worth $1.26 million today versus ~$51k in the S&P 500.

EV Sales are still small but growing rapidly.

Retail buying of used EV’s will grow even faster and Tesla has the most to gain as trailblazer!

Eric Clark

April 10, 2023

How to Play Offense & Defense in a Portfolio: Part 1 – Defense

Eric Clark

April 10, 2023

Key Points

A balanced portfolio holding companies that play offense & defense is key.
In the new economic regime, certain style factors make the most sense.
Certain “defense-oriented” brands are performing quite well today.

Balance in a portfolio can help smooth the bumps to offer a smoother ride.

I wanted to do a two-part series, one focused on the benefits of holding defensive business models that tend to perform well in more difficult economic periods, and one focused on playing offense through secular growth brands. 2022 was an odd year, the highest quality secular growth companies generally delivered solid fundamental business performance, yet their stocks generally got absolutely annihilated. Generally, it was the contraction of the multiple, or what investors were willing to pay for high quality, that the market clearly questioned. Ironically, many of last year’s best performers turned in average operating performance but money flowed to these stocks because they were “defensive business models”. The growth of passive investing and ETF’s has driven this basket of stocks mentality whether there is any logic or not. In the end, what makes an asset price go up is simply having more buyers than sellers.

At the highest level, I think investors have three main goals from the investing they do:

Achieve attractive returns.
Have as smooth a ride along the way as possible.
Reach their target goal on time and intact.

How they accomplish these three goals is where the magic happens. In many cases, it’s BALANCE that helps them smooth the ride. To get some balance, defensive business models and the stocks of these companies are where investors can turn.

Important style factors for the new investment regime.

Style factors describe the characteristics of a business. Defense or offense. High quality or lower quality, highly levered or low leverage. Large versus small. Domestic sales versus international sales. Our team tracks a few dozen style factors so we can see where the returns are coming from in the market. Think of this like a pond for fishing. When the fish are only gathering in one part of the lake, the fishermen should gather there too. Our portfolios generally hold a portion of the companies with a high weight toward style factors that are working as well as having some exposure to companies that are out of favor but likely to see some resurgence in time. That way we always have some balance to the portfolio and there’s always a new emerging winner to consider. Overall, we tend to always be overweight the “quality” style factor partly because it tends to outperform long-term and partly because top brands tend to be high quality companies.

Year-to-date, the quality factor has gotten back to performing well after having a difficult 2022. Within the quality factor, these are some of the sub-factors that are working again: high free cash flow, high free cash flow growth, pricing power, strong balance sheets, revenue growth, better margins than industry peers, dividend growth and margin expansion. I have written many times; the big opportunity is to add to outperforming style factors when they go through shorter periods of underperformance. It may feel bad when you add but when you know how the movie ends, you’re never afraid.

Defense

Alabama coach Bear Bryant used to say, “defense wins championships.” The truth is, having a solid defense AND offense tends to win championships but in markets, defense tends to win in tough, uncertain economic environments because companies that have more defensive business models tend not to suffer big erosions in revenues and earnings. Their stocks tend to underperform in up markets and outperform in down or sideways markets but sometimes there are special companies that win more of the time. Having some exposure to both types of companies seems to make a ton of sense today. With that in mind, I wanted to discuss a few gems that seem to be all-weather brands while still having strong defense-oriented characteristics:

Hersey: HSY

Consumers all over the world love their snacks and chocolates. Hershey has been a monster in the industry and a stellar investment over many decades. The company is one of those special blends of stable, predictable grower and a key defensive for more turbulent economic periods. When you are happy, you snack. When you are sad, you snack more! Hershey management has been making very strong acquisition decisions in the snacking category and they are not done. Consumers love their products and have voted with their wallets. The brand has strong pricing power, understands how to integrate an acquisition and drive higher volume growth. From a style factor perspective, HSY scores incredibly well in key defensive areas: dividend growth, higher margins than peers, attractive dividend, strong FCF growth, size, low volatility (beta), high return on invested capital when compared to the weighted cost of capital (WACC), and very stable, predictable earnings trends. The perfect stock for this environment in our eyes.

Fun fact: HSY stock has handily outperformed the Consumer Staples sector, the top performing broad equity style, growth, and the Nasdaq 100 over the last 1, 3, 5, 10, 15, and 20 years. Something as simple as snacks and chocolates can add a lot of value to a portfolio.

Costco: Cost

First, I’ll admit something: I do not like the shopping experience at Costco. And yes, I’ve been a member for many years and yes, we visit Costco every week. That’s how powerful this model is. With the best management team in retail, Costco has been serving consumers globally for many decades. Imagine a business model where consumers pay the brand for the right to have access to the stores and its merchandise. Member renewal rates are about 90% and we all get great values when shopping at Costco. Yes, this great brand was a big Covid beneficiary but once you jump onto the hamster wheel, it’s hard to jump off. Their private label brand, Kirkland is a monster and would be the dominant category killer in most sub-categories if it were an outside brand. It’s estimated to have an annual revenue run rate of about $75 billion. Costco runs on slim margins and high volume so when you have significant private label success, you can expand margins without affecting consumer price points. There’s so much more store growth possible outside North America as well.

From a quality and defensive business model perspective, Costco scores quite well. High sales, strong economic moat, high free cash flow, top quartile dividend growth, still cheap on a price to sales basis, low debt, strong balance sheet, incredibly predictable earnings, very low default probability, and a significant amount of cash on the balance sheet.

Like Hershey: COST stock has handily outperformed the Consumer Staples sector as well as the top performing broad equity style, growth, and the Nasdaq 100 over the last 1, 3, 5, 10, 15, and 20 years.

My question to every reader: what percent of your portfolio holds stable, predictable brands that can play offense and defense while delighting you on a regular basis? I urge you to look around your house and identify which brands you will turn to in good times and bad. If the masses also feel that way, there’s a good chance they have been stellar investments too.

Eric Clark

March 29, 2023

Quality + Brands + Private Market Opportunities

Eric Clark

March 29, 2023

Key Points

The Brands Fund, while being volatile at times with wild markets, continues to have a comfortable lead on the S&P 500 YTD. The quality factor, has come back en vogue. Please make sure you have sufficient exposure to this style factor. It's likely one of the most important factors to lean on during periods of uncertainty.

Market comments

There's a ton of uncertainty these days and short-term we could see an acceleration of this uncertainty. That likely means clients are experiencing an elevated amount of angst. That puts pressure on them, on you, and ultimately on their interest in sticking to your long-term plan. It's in these times that an investor can make knee-jerk decisions that get them off course. Holding a lot more cash or perceived safety assets is a decision that always feels good at the time, I respect that. The problem tends to be getting back in. The best times to dive back in the pool (low prices) are always during periods when most people want to be as far away from the pool as possible. Most investors lead with their emotions and emotions rarely lead them to make solid investment decisions. That's where experience and a willingness to be greedy when others are fearful can really add value to a client relationship. Blackstone, KKR, Brookfield and others are the best at buying fear and panic and these three alone have over $380B of dry powder available currently. These are savvy, patient investors. Private lending, in particular, has a very robust opportunity today, as banks retrench and private markets become price makers and offer the bespoke solutions that companies need. When you are a price maker, the terms and protective covenants are highly in your favor. Their expertise is working for us in the fund.

The Set-up:

For a variety of reasons, a higher resting heart rate for inflation, fed funds, rates, and the cost of capital should be the expectation for the foreseeable future. Not every asset class or company will thrive in this environment and it could be a wild ride at times given such a long period of zero rates and free money. Zombie companies keep floating to the surface right now. Thankfully, there are a handful of timeless investment thematics (global consumer is one) as well as many "alternative" investment options available to investors. Everyone needs some exposure to the most opportunistic asset managers in the industry yet few actually have it and they are not readily available in ETF's. You get that exposure in the brands fund. Most HNW investors are incredibly overweight the liquidity factor yet it causes angst, often pushes people off course, and is the opposite of how the smartest endowments manage assets.

Investors simply want this: Adding an allocation to Alts can be a solution.

1. Attractive returns over time.

2. As smooth a ride as possible along the journey.

3. To reach their goals, on time, and in-tact.

Fun Facts: See the image below for asset class returns 2007 - Q3 2022

1. Institutions like Endowments tend to perform much better than HNW investors.

2. These Endowments tend to have about 30-50% of their assets in Private assets.

3. Privates, on average handily outperform public comps with much less VOL.

4. The average HNW investor portfolio annualized return over 15 years is ~6-8%.

5. Top Endowment portfolios like Princeton, Harvard, Michigan, have average annual return is ~12-13%. Princeton's annualized return since 1977 has been +13%, they hold a very high weight to "alts" at ~70%.

Building a portfolio of solid, timeless thematics PLUS a handful of private alternatives can really add value to a portfolio and offer a smoother ride along the way. The new regime stated above is the catalyst for these potential portfolio changes. In equities: pricing power, solid balance sheets, big market share, high FCF, and margin stability are key. Yes, I've just defined an iconic, highly relevant global brand. Keep your eye on the prize, great brands make great investments and the savvy investor uses periods of turmoil to accumulate more great brands.

bottom line

Investors are scared, confused, and likely questioning their investments during this normalization process. Re-connecting with them and taking their emotional temperature is likely a very good idea. In order to help you accomplish this, we created a quick 30 question Q&A template to help identify what they really want & need these days. It's a great model you can use as a starting point for spot-checking your portfolio models for proper suitability.

Investor profile & behavioral temperament quiz

Eric Clark

March 29, 2023

How Advisors Can Act in Their Clients’ Best Interests When It Matters Most

Eric Clark

March 29, 2023

Key Points

Advisors have a fiduciary responsibility to act in their clients’ best interests.
Knowing your customer and being laser-focused on investment suitability is vital.
The discovery process between advisors and clients & potential clients needs a facelift.

Investors are more confused than ever

Over the last 3 years, we have experienced a global pandemic, 2 equity bear markets, wild volatility across all asset classes, a historic tightening cycle led by the Federal Reserve, the highest inflation in 40 years, a de-anchoring from zero interest-rate policy, interest rate spasms, the worst returns for a 60/40 portfolio in our investment careers, and a brand-new banking crisis. Investors and advisors have a lot on their plates these days and keeping clients engaged while helping them protect themselves and sleep at night is as difficult as it’s ever been. I thought I would spend a little time this week highlighting some important ideas that can help streamline the process of keeping happier clients and helping them reach their goals in difficult markets. In order to accomplish this, getting back to basics might be in order. It’s time to revisit our clients goals, objectives, and needs and also to help protect ourselves as fiduciaries.

Know your customer & be laser focused on proper suitability

FINRA Rule 2090: Know Your Client Rule (KYC). It requires advisors to know the “essential facts concerning every customer and concerning the authority of each person acting on behalf of such customer” when opening and maintaining a client investment account. Unfortunately for advisors, the process of discovery is a fragmented one and things often fall through the cracks. Every firm has their own forms and processes, and every advisor tends to have their own approach to getting to know a client or prospective client. Sometimes it’s a yellow note pad and a face-to-face conversation(s) and other times the process gets more automated using technology and an online questionnaire. Regardless of the process, the data ultimately needs to get stored & updated periodically. That’s where the potential problems or deficiencies often begin. Fortunately, with the advent of sophisticated CRM platforms, the client information is now able to be accessed and altered as circumstances change.

FINRA Rule 2111: Suitability

Every year, there are thousands of customer complaints filed with FINRA citing poor recommendations that led to bad outcomes driven by problems with suitability. In its simplest form, advisors determine the suitability of an investment via matching proper investments based on a customer’s real-time investment profile. I say “real-time” because the goals, objectives, risk tolerances, time horizons, and return expectations change as a customer ages. If the customer profile doesn’t get updated as their needs and preferences change, the recommended investments may deviate from the original purpose creating a “suitability” mismatch.

When markets are quiet and most asset classes are generating solid returns with lower daily volatility, clients are generally happy and content. But when the economy has a problem and asset values get volatile, clients often begin to critique what they are invested in and whether each investment is still an appropriate choice for them. If clients do not fully understand and appreciate what they own and why, a wedge often creates created between them and their advisors. It’s times like today that revisiting the suitability and know your customer rules add the most value to everyone concerned. Using today’s uncertain world as the air-cover for catching up with clients is a wonderful way to service them, build deeper ties, and update investment portfolios. My general rule, when the client profile & suitability changes, so too must the portfolio recommendations & allocation weights.

Automating the discovery process can protect you & enhance your client relationship

As I stated earlier, every firm and advisor team has their own process for building an investor profile, storing the data, and updating the data over time. Because client sophistication and market knowledge tend to have a wide gap, I thought I would create a resource for advisors to use as a template for re-connecting on suitability metrics given clients’ current angst with investments & markets. The daily volatility we are seeing now can have a lasting effect on an investors willingness to take risk for goal achievement. The link below is meant to be used as a collaborative tool between the advisor and his/her clients on a 1-1 basis. How a client answers the 25 questions will paint a clear picture of: 1) their risk tolerances, 2) their return requirements, 3) their customer service preferences, 4) their time commitments, 5) their liquidity needs are, 6) what an appropriate mix between public and private alternatives might look like, and 7) what their behavioral temperament towards taking risk is. Once an advisor has this data, making sure they have the most prudent portfolio mix that matches back to their profile gets a lot easier. I can guarantee you, using something like the discovery process below will make it much easier for you to go line by line across an investment portfolio to spot-check if proper suitability is intact. Whether you go through this assessment online together and I send you the results or you use what I have created as a general guideline, I hope you find the quick assessment helpful and useful.

One opportunity you will likely uncover: more clients would prefer to be shielded from the day-to-day volatility of traditional stocks, bonds, and in public markets. This might lead to deeper conversations about public and private market exposures that might be more suitable. The bonus: to have a less volatile ride along the way, clients are likely willing and able to give up some daily liquidity or to consider asset classes that offer less correlation to traditional stocks and bonds. And you get the opportunity to re-connect and build a more institutional portfolio.

Take me to the Investor-Advisor Profile Quiz

If you would like to discuss this Q&A assessment 1-1 with me, I’m happy to chat. My email is eric.clark@accuvest.com.

Eric Clark

February 28, 2023

HOKA: A Growth-Beast in Athleisure & Global Footwear

Eric Clark

February 28, 2023

Key Points

Nike is still the undisputed global footwear champion, but growth is slow.
Niche footwear brands are taking market share from the largest brands.
Growth at Hoka has been extraordinary, there’s a lot of low-lying fruit to capture.

The global sneaker market is roughly $152.4 billion as of 2022

Let’s talk athleisure because it’s a powerful secular growth theme and there’s some absolutely dominant brands in the category. We can’t talk about sneakers and footwear without leading with Nike. Nike is one of the most recognized and loved brands around the world. Once called Blue Ribbon Sports, Nike was founded by Bill Bowerman and Phil Knight in 1964. Nike is one of the great corporate stories of all-time. Phil used to sell the new shoes out of his car just to spread the word about the new brand. Back then, Adidas and Puma were the big dogs in the industry and runners where a shoe brands primary target. Today, the athletic footwear industry has morphed into something much larger as consumers tend to own a handful of shoes for different purposes: everyday life, running, cross-training, etc. The message has never changed: brands focused on comfort, durability, a cushioned innersole, attractive colors and designs, and overall great support (toe to heel and lateral for ankle support) have strong growth opportunities. Today, the footwear category has blossomed, and dozens of niche brands are becoming real competitors to the incumbents.

Hoka: Quietly becoming very relevant.

As an investor in iconic and highly relevant brands, I’m always on the lookout for up & comer brands.

Each December, our team gets together to assess all the spending categories while analyzing the brands that seem to be winning, losing, and emerging from a market share perspective. Nike has a very long lead and is a marketing machine, but their size and global scale turns the stock into a steady-eddy brand versus a strong and sustainable growth brand. Our holding in Nike is about the dividend growth opportunity and about a shift towards e-commerce and digital while building a deeper direct relationship with consumers. We still see strong margin expansion opportunities for Nike along with better inroads in Asia and Emerging Markets.

Now let’s talk about our growth pick. Hoka has largely been a niche running shoe brand that has been flying under the radar of most peers and consumers. Acquired by Deckers Outdoors (DECK) in late 2012, Hoka has one of the most impressive growth profiles across the footwear category. What started as a niche running shoe and one with a very peculiar design, has morphed into a much more diverse footwear brand that appeals to kids, adults, and older adults. The international expansion is still in the early innings and brand awareness, while making strong inroads, still has a significant amount of growth ahead. That’s the kind of story that excites us when we are looking for undiscovered brands and strong growth that’s not well understood by the street. My experience with Hoka started with trail running shoes and I have been a loyalist ever since. Now, my wife has 2 pairs, my daughter has one pair (Nike is the coolest after all), and the grandparents all have at least one pair. They are unbelievably comfortable, give you great ankle and arch support and have finally started to expand the color palette which used to be a bit boring. Check the shoes out here: https://www.hoka.com/en/us/

Let’s look the sneaker market share peer group from 30,000 feet. Here’s what market share looks like according to Statista with a 2020/2021 viewpoint.

Nike is 2x larger than Adidas, which seems to be shrinking every day while losing relevance with consumers. After Adidas, the competitors drop off meaningfully in terms of annual revenues to footwear. As you can see, Hoka is not on this list yet, but they will be soon as the brand recently crossed over $1.0 billion in annual sales and still with one quarter to go in fiscal 2023. For the year, Hoka should reach about $1.2-$1.3 billion in sales which is a remarkable accomplishment considering fiscal 2018 sales were $153.5 million for a compound annual growth rate of roughly 50%. Hoka is taking meaningful market share at the lower end of the annual sales peer group and Under Armour, Skechers, Asics, and New Balance are likely feeling the pinch the most. Nike is too big to feel Hoka’s bite for now, but I can guarantee you, what was an easy Nike sale is no longer easy when other brands are becoming more relevant, have a better reputation for solid construction & support, and are at more attractive price points. As consumers feel the pinch from inflation, more trade-downs will occur and Hoka should continue to benefit. Here’s the annual sales trajectory of Hoka between 2018 and Q3 2023. Remarkable quarterly sales and growth from $30 million in Q1 2018 to $352 million in the 3rd quarter of 2023.

At Deckers Outdoors, Hoka is the growth brand, but UGG is remarkably stable.

Deckers is still a small-ish company at roughly $10.5 billion in market cap and $3.6 billion in trailing 12-month sales. The stock has been a stellar performer over the last 20 years with annualized returns of 17.4% versus the S&P 500 at roughly 9.8% annualized. The UGG brand at Deckers has been the growth workhorse but Hoka has taken over and it has fresh legs. The UGG franchise still does about $1.7 – $1.9 billion a year in revenues. Growth is now slower but by no means has growth stalled at this brand making the UGG division a key driver of spending capacity for other initiatives and share buybacks. UGG truly is the gift that keeps on giving.

Sum of the parts:

At $10.6 billion in market cap, DECK trades at about 2.9x sales. For perspective, Nike trades about 3.8x sales and roughly 62% of total sales comes from footwear. If I use a pure peer comp via a fast-growing footwear brand called On Footwear, Hoka, if it were a standalone brand would likely be worth about $7-$8 billion currently. On Footwear trades at 6x sales given they are growing in similar fashion. Investors like pure exposure to themes so typically, the pure play grower in a group trades at a higher multiple than a conglomerate with many brands under one roof. Tesla is a good example of this in the EV space as the pure play at scale option for investors. Currently, the Hoka brand and its annual sales is worth about 62% of the total market cap of Decker’s and it’s still in “beast growth” mode. When you see faltering brands like Skechers with about $7 billion in shoe sales, Asics with almost $3 billion in sales, and serial underperformer, Under Armour at roughly $1.3B in shoe sales, you start to see how much growth potential there is for Hoka.

Our team estimates the Hoka brand being worth roughly the current market cap of the entire Decker’s company making the stock of DECK quite cheap. In our estimation, Hoka will continue to experience outsized growth because its sitting in the sweet spot for footwear growth just crossing $1 billion in sales. We estimate Hoka has another $4 billion in annual sales until it starts to experience the typical growing pains of most footwear brands. Given the current persistent inflation and its effect on consumers, we do not expect growth across consumption categories to always be linear, but we have very high confidence in Hoka’s growth trajectory long-term. That makes the stock of Decker’s, one of our favorites for the next 3+ years given the sum of the parts analysis and the strong growth opportunities within Hoka.

Deckers Management: Exceptionally Strong Capital Allocators

Another reason we love this company, is our confidence in management. They have consistently reduced the share count since 2010 and used strategic buybacks to their advantage. Deckers management does a tremendous job managing the cycles, inventory, and the balance sheet. The current buyback of roughly $1.5 billion amounts to about 14% of the current market cap. They have a track record of smart, accretive buyback decisions and the company has zero debt and about $1.05 billion in cash. With strong and stable gross margins, a stable predictable UGG brand that generates strong cash flows, and a growth brand in Hoka, the stock is highly attractive and significantly undervalued, particularly relative to the peers in athleisure and footwear.

Eric Clark

February 16, 2023

Monetizing Uncertainty Through Investments in Alternative Asset Managers

Eric Clark

February 16, 2023

Key Points

Uncertainty & 2022 macro PTSD is still high across markets.
Every portfolio deserves an allocation to the smartest investors & their strategies.
Alternative asset managers are embedded with a coiled spring of future earnings

Investors are still focused on macro versus company micro fundamentals.

The difficulties of navigating markets in 2022 are well chronicled. Very difficult years tend to create investor PTSD, which often holds them back from uncovering opportunities. In my conversations with advisors and analyzing money flow data, there appears to be lingering apprehension for risk-taking initiatives. While it’s quite natural to feel nervous driving a car after a car wreck, often the only thing holding us back is our fear of yesterday’s boogie man. In the investment business, great opportunities are presented when markets struggle and fall. Macro can only carry us so far before the company fundamentals and their long-term opportunities again take the wheel. While the world is still waiting for the next shoe to drop in macro, high quality companies continue to perform well, adapt to the changing environment, and their stocks have had nice recoveries thus far in 2023. We expect volatility to stay elevated because there are still some outstanding items needing more clarity. But largely, our work suggests that brands with strong balance sheets, free cash flow generation, and large untapped market opportunities will exceed lowered expectations and their stocks will turn in much better years versus 2022. Perhaps it’s time to shift our focus away from macro and trying to predict the next black swan event and focus on investing in the themes and companies best positioned for the new normal of higher inflation, rates, and the cost of capital.

Monetizing today’s uncertainty through the best investors on the planet.

If you want to know who some of the smartest investors are, I urge you to go buy a new book or audiobook from Private Equity pioneer, David Rubenstein, the co-founder of The Carlyle Group, a global private equity investment manager.

The book is called, “How to Invest” and it was released recently. I could not put this book down and read it over a 5-day period while visiting family in NJ. Here’s a link for your convenience:

Book: How to Invest.

David interviews some of the smartest and most successful investors in the world. They include: Larry Fink, Ron Baron, Bill Miller, Jon Gray, Sam Zell, Seth Klarman, Ray Dalio, Stan Druckenmiller, Jim Simons, John Paulson, Bill Ackman, Sandra Horbach, Bruce Karsh, Marc Andreesen, and Michael Moritz of Sequoia Capital to name a few.

Widening the investment lens to longer time periods and cloning what the smartest investors do is a powerful one-two punch for a portfolio. The facts are clear, the longer the time period, the higher the odds for investment success. Who are the most successful investors and those that focus on long-duration investing? The alternative asset managers and private equity firms like Blackstone, KKR, Brookfield, Apollo, etc.

There is a mega-trend under way in our industry and the game is in the early innings. With the democratization of alternative assets well under way, investors can either invest in specific thematic funds managed by great firms or they can invest in the stocks of the firms themselves or do both. The statistics show the average HNW investor still only has a small portion of their total assets invested in alternatives and the evidence is as clear as day when looking at the benefits. A great future lies ahead for asset gatherers in this space.

Institutions have been allocating a significant portion of their portfolio to “alternatives: real assets like differentiated real estate, infrastructure, renewable energy and energy transition, private equity, venture, private credit, growth equity” for decades. Why would any investor not want to piggy-back that well-researched approach for their personal portfolio? Our team has significant exposure to the leading brands in alternatives because they have excellent track records across all investment disciplines and because they see the world from a 30,000-foot view better than most of the investor universe. 2022 was a difficult year for alternative asset managers from a stock perspective. No matter what opportunities you have in front of you, when there’s a bear market and you are a publicly traded stock, your stock trends down like the rest of the market. However, a look under the hood highlights what an incredible year of fund raising each of these brands had in 2022. Blackstone raised $226 billion of new capital, KKR raised $81 billion, and Brookfield raised $93 billion. These firms raised more capital in one year than the total assets of most investment managers!

For investors in these firms, here’s where it gets interesting. Each firm will begin to generate attractive fee revenue over time from this new capital. New fees from this dry powder being put to work, plus fees from existing fee-paying AUM, plus future monetization’s and performance fees, will all lead to a coiled spring dynamic for the earnings of these firms over the next few years. Investors that are too short-sighted miss the staggering step-up in revenue these firms will have over time. That’s why we love these stocks today.

Bonus: owning the stocks of these great franchises is by no means a crowded trade, the stocks of the smartest investors in the world are heavily under-owned by institutions and individuals and they aren’t yet included in the major indices. I expect this to change in time as index committee’s get more comfortable with dual share class corporate structures.

Private markets offer a smoother ride.

The daily pricing mechanism in public markets feels comfortable until it doesn’t. As investors, we have grown accustomed to assuming the day’s closing price is the true and realistic value of a business. In an algo-driven world where about 70-80% of the daily trading volume comes from computers, it’s simply unrealistic for public market pricing to be a real assessment of corporate value. As a private market’s investor, company valuations are not tied to the daily volatility of public markets. Public markets and values tend to be tied to wild swings in sentiment where values in private markets are driven by deep analysis by third-party auditors, peer comparisons, and rigorous discounted cash flow models. In addition, these firms are probably the most opportunistic investors I have ever seen.

Their best long-term return vintages always begin when prices are low, and anxiety is high. They have a history of buying when most of the world has retrenched. Isn’t this the type of company you should want in your portfolio? To own great companies with enormous forward opportunities, one must be willing to assume some volatility along the way. There is no free lunch on Wall Street.

Below is a quick re-cap of the three alt asset managers we own in portfolios: Blackstone, KKR, and Brookfield Asset Management. I took this information from their latest quarterly reports. These leading brands manage a current AUM that totals roughly $2.3 trillion, with fee-paying AUM at $1.55 trillion and growing, and most important for opportunistic investors, they have about $386 billion in dry powder to be put to work into any distress that happens around the world. These are very savvy and patient investors, the optionality they have with so much capital to deploy should allow anyone to sleep at night.

Performance is the proof-point.

Analyzing performance across the alternatives category can sometimes be difficult, but largely the industry has done a very good job of generating strong excess returns per unit of risk taken, particularly when compared to most equity and fixed income peers. Below is a powerful chart from leading firm KKR showing the since inception IRR’s across the product suite since each strategy was created. The look-back performance across each asset class is even more attractive at Blackstone.

Remember, if you cannot gain access to the investment products managed by Blackstone, KKR, Apollo, Brookfield, Carlyle and others, their stocks are publicly traded and are trading at what our team considers to be “heavily discounted” prices. These firms are all set to compound their fee revenue as well as accelerating monetization’s as markets and economies normalize. Consensus analyst expectations are simply too low in our opinion.

Here’s another great slide from KKR’s recent report highlighting the potential growth of the stock if their long-term goals are met. Hint, these firms have a history of under-promising and over-delivering. KKR stock is trading at roughly $58 on February 13, and using various assumptions around future distributable earnings and the appropriate multiples for these assumptions, there’s some significant upside potential here and across the group because every firm we own has similar long-term growth opportunities to monetize for LP’s.