‍As the curtains fall on 2023, stock investors are performing their annual ritual of portfolio reflection—bulls and tech-heavy investors with satisfied smiles of fortune's favorites, bears & value investors with the furrowed brows of the less favored. It is like 2021 all over again. Just check how value vs growth is diverging again in favor of growth:

If you have been following me on Etoro, you may have noticed the volatility of my results has decreased significantly, and so did my "risk score". This is because I have been shorting a sizable position on the tech-heavy QQQ index which ended to new highs by the end of the year. As you can imagine, this one did not do well, even though it did. Let me explain. I never bought the tech rally this year, and this short QQQ was meant to allow me to "wait and see" without too much exposure to growth stocks with which my portfolio was mainly built. So, even though my short position is in deep red, the rest of my portfolio did very well, with the overall making +17% in 2023.

So how is this good news?

The good news is that I can follow an investing plan 🤓! And it did what it was supposed to do: lower our exposure to high volatility. I just did not think economists were so deadly wrong about the state of the economy. Still, I would be making my victory lap if economists were good at their job, and the "worst case scenario" is the current one where we still managed to make +17%.

Enough talks about the past, what does the future have for us?

Reasons to Rejoice about Investing in 2024

A Stable Stock Market Landscape

Investors have a lot to cheer about as we step into 2024. The stock market seems to be holding its fort with some big-name analysts projecting the S&P 500 index to grow by 5%.

Inflation under control

Inflation, the invisible arch-enemy of consumers and businesses alike, is expected to take a back seat in 2024. This decline is anticipated to reduce the financial burden on consumers and businesses, allowing them to breathe a little easier.

A Favorable Job Market

The unemployment rate for 2024 is projected to remain low, painting an optimistic picture for job seekers and businesses. A thriving job market is an indication of a strong economy, although it sometimes drives more inflation...

Anticipated Interest Rate Cuts

Another feather in the cap of investors is the expected cut in interest rates by the Federal Reserve. Lower interest rates could make it more attractive for businesses to finance their growth, potentially leading to a higher return on capital.

The Dark Clouds: Risks to Watch Out For this 2024

Vulnerabilities in the Global Economy

Despite the recent decline in inflation, the global economy is not entirely out of the woods. Europe faces the threat of a recession, while America might dodge this bullet.

China's Economic Slowdown

China's economic slowdown is a growing concern for investors worldwide. Any turbulence in the Chinese economy could have ripple effects on global markets, making it a significant risk factor. Home prices are a time bomb for the Chinese middle class and political stability.

Geopolitical Tensions

The geopolitical landscape is another element that could stir the calm waters of the stock market. Rising geopolitical tensions, Ukraine and Palestine to name a few hot spots, could hinder global trade and economic growth, thereby impacting investment returns.

A Potential Housing Market Correction

JPMorgan has highlighted a potential housing market correction as one of the biggest risks to the global economy. A sudden drop in housing prices could trigger a financial crisis, reminding investors of the 2008 recession.

The Trump Factor

The potential re-election of Donald Trump in the United States could exacerbate economic uncertainties and heighten market volatility. His policies and decisions could have far-reaching impacts on the global economy and the stock market.

A Soft Landing for the Global Economy

Economic forecasting is a tricky business, as the majority of economists predicted a 2023 US recession which never happened. However, despite its challenges, it offers valuable insights into potential market trends and risks. What most economists are saying is that the global economy in 2024 is on track for slow growth (aka "soft landing"). So it is like the start of 2023, but upside down: all are optimistic. This means any misstep along the way would entice Wall Street to punish bulls as this is a game of expectations. So yes, I put the good economic mood as a risk factor.

US Market Valuation

When it comes to the US market valuation, I am sounding the alarm bells. The Shiller PE ratio, a reliable measure of market valuation, is currently at 32.4. This is a whopping 23.4% higher than the recent 20-year average of 26.3. I get to a similar conclusion (fair value of barely $4.000 for the S&P500, more than 20% higher than today´s price) with a classical DCF model taking into account earnings forecasts for the next couple of years.

GREEEED

AAII investor's sentiment is extremely optimistic, with the 8 weeks average bullish ratio as high as 47%, way into the greed territory (aka more than one std deviation from the historical mean), and the CNN "Fear & Greed " index is flashing"Extreme Greed".

This is a problem because when greed takes over, investors tend to overlook the fundamentals and chase after high returns, often leading to risky investment decisions. This could result in a bubble, which when bursts, can lead toextreme swings.

Wall Street analysts and Economists are mostly useless, but sometimes they do make sense. This is what I learned from reading the market outlook of JPMorgan, Citi, Wells Fargo, Goldman Sach, and a few more like it.

The Fixed Income Investing Opportunity

Because of the anticipated cut in interest rates, fixed-income and high-quality credit markets may offer attractive opportunities for investors (bond prices rise when interest rates decrease). The risk-reward ratio seems like a no-brainer as US treasury bond prices are still close to their lowest point from the past 15 years.

Emerging Market Opportunities

Emerging markets offer higher growth and returns, making them attractive to investors. However, careful evaluation and understanding of country-specific risks are essential. Mexico and India are two emerging markets that are expected to outshine others in 2024 according to many Wall Street analysts. What is starting to be a pattern is that most see non-US markets as better valued and, hence offer greater expected returns. GMO even has an "expected long-term returns" by market on their site, and it looks like this:

The Digital Gold Rush: Investing in Cryptocurrencies

Cryptocurrencies, the modern-day digital gold, are proving to be as resilient as roaches. Despite market volatility and regulatory crackdowns, cryptocurrencies have managed to survive and thrive. Their decentralized nature and innovative underlying technology make them an appealing investment option for risk-tolerant investors. BTC made its way into my second biggest position within my portfolio, don´t expect me to sell.

My game plan for 2024

Fortune favors the brave, and in the world of investing, the brave are those who dare to stay informed, stay resilient, and don´t necessarily follow the crowd.

Being brave at the start of 2024 is being the contrarian, the bear. I am not making substantial changes to my holdings, but I will slowly increase my QQQ short position to better face what I see as highly probable backlashes. I also opened a long-term US bond ETF $TLT. So yes, it is more or less the same play as last year, just that it is now the contrarian play, which I like better this way.

There are a few gems out there that I am looking to enter, combining my rookie investor scorecard to make sure these are quality companies with my "price expectation checker" to avoid frosty valuations and increase our risk-reward ratio. Right now, I see many such opportunities, like DOCU, CRWD, MELI, and BL just to name a few. On the other side of the coin, I will trim some positions that are trading in extremely high-expectations territory, like what I did with NVDA. I have a few candidates on this list, such as ADBE, ASML and SNPS, but I need to deep deeper before taking a stance.

Last but now least, I have been working hard (and spending a ton on data scientists and statisticians consultants) to build a quant model (aka AI-powered predictions based on hundreds of market fundamentals) to better size my short QQQ position. I expect to start using it during the first half of 2024. Very excited about this.

The market is extremely hard to read, and bubbly as hell. I am finding peace in my "market neutral" strategy, which got my risk index to its lowest level on record (aka level 3 for eToro customers). I am not quitting it anytime soon. Here is why.

Theme 1: Inflation Trends

Keep an eye on the big picture:

• Inflation is cooling. The latest numbers show that core inflation (excluding food and energy) is rising at its slowest pace in two years.  The speed of adjustment is slow, and it most analysts expect it will take about two years to bring core inflation down to the 2.X % target.

• The labor market is still hot. There are more job openings than unemployed people, and wages are rising. Not good for long term inflation.

The bottom line:  don't panic. In the meantime, focus on your long-term goals, it is advisable to hold tight and not make any significant changes to your portfolio. It does seem like new inflation target are now out of the question which should greatly benefit the so called "growth stock", aka tech stocks that lose money but grow at astonishing paces.

Theme 2: Investors' Confidence and SP500 valuation.

Retail Investors are at last out of the fear territory, according to the AAII surveys, but not yet in the greed territory. What does it mean? It means don´t panic, but greed is close, and we get another couple of weeks with market gains, I would expect FOMO to win back our emotional state, we know what usually happens next. I do note that the fear and greed index built by CNN based on transactional data is already in the "extreme greed" territory. Insiders are not buying too much either.

Bottom line: contrarian thinking suggests it is still fine to invest, but at the current SP500 valuation (around 20% overvalued vs. my estimated intrinsic value), and greed nearby, market momentum could quickly switch to negative. I am adding slowly to my short QQQ position which has been trimmed by 22% because of the recent market uprising. This strategy, known as "market neutral", got my risk levels measured by eToro to its lowest level on record.

Theme 3: US Consumer Resilience

US consumer resilience is a key variable to watch, and it the consumer confidence index measured by the OECD for the US is slightly higher than the second half of 2022. So far, strong demand has allowed companies to pass through higher costs to consumers, but these benign conditions should(/may?) fade. Savings will dry up, and tighter lending conditions are worsening the outlook for consumers. A deterioration in US sales and EPS is expected. Most economists expect a recession, but Wall Street Analysts do not... volatility loooves expectation gaps.

Bottom Line: Investors should be cautious about investing in US consumer stocks in the second half of the year, and something has to give sooner or later. Make sure your portfolio is not overexposed to it.

Theme 4: Mega Forces

Mega forces are structural changes that could create big shifts in profitability across economies and sectors. These include the rise of artificial intelligence, the rewiring of globalization driven by geopolitics, and the transition to a low-carbon economy, to name a few. The key challenge here is to identify the catalysts that can supercharge them and whether all this is priced in today. For example, I think all of the AI hype is already cooked in Nvidia price, but since I sold it went up 70% so who know? I do think this checks the box of a "bubbly" market.

Bottom Line: Investors should consider investing in companies that are well-positioned to benefit from these mega forces, expect higher prices for those, but there is a limit to what you should pay. For the answer to that, do your own homework and keep in mind basic valuation methods, if you use multiples, you are using "pricing", not "value", methods.

Just a month ago when I wrote "from this level, I would not expect a market-beating return from an investment in Nvidia today, looking at the next 10 years", I was valuing NVDA at around 183 USD per share. It is now 393USD per share and counting, so WTF happened? Do their latest earnings change everything? Or am I just a fool? Let's dig into it once again.

What new bytes of info do we have about NVDA?

The surge happened after announcing a revenue target of $11 billion for the quarter ending in July, far exceeding the consensus forecast of $7 billion. Microsoft's €10bn investment in OpenAI (the company behind ChatGPT) probably helped too.

Analysts say Nvidia is currently the only viable supplier of GPUs, leading the company to double prices to meet the overwhelming demand generated by the ChatGPT hype and the subsequent product release race between Big Techs like Microsoft, Google, Adobe etc. It seems Nvidia powers about 80% of the computers behind these so called "Generative AI" products. That gives them a lot of pricing power.

“If you order a GPU today, you’re not getting it for a year,” said C.J. Muse, senior managing director at Evercore ISI

How does it impact the NVDA valuation story?

Nvidia only gave guidance for next quarter, but the general Wall Street consensus is now that revenues will grow 58% for the full year, vs a forecast of 11% just a month ago. The thing is, after 5 years, analysts consensus expect revenues of about $108B, which is just $4B higher than projected in my last valuation, so it just change the pace of change rather than the final market size.

The biggest impact is not so much about revenue growth, but rather what it means for Nvidia pricing power, hence operating margins. Analysts expect an insane 62% EBIT margin by 2027, 4 percentage points higher than projected a month ago

These 2 changes alone explain a jump of 60% in the instrinsinc value I calculated a month ago. But at $295 USD per share, it is still 33% below today´s price . Here is the link to the updated valuation spreadsheet.

So what´s my next move?

Of the 49 analysts surveyed by FactSet, 41 have a buy rating on the stock. Their average 12-month price target on the stock falls just below $436. This is just a reminder that, as Aswath Damodaran, aka the "Dean of Valuation" puts it, Wall Street analyst don´t value companies, they "price" it. In fact, Aswath declared last week on Barron´s Streetwise podcast that he sold his personal shares of Nvidia because the price is too far away from the story he is willing to tell.

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To answer the question from this post title, I feel pretty good actually, it is much harder to feel FOMO and other useless emotions when you do the homeworks and understand the valuation story. I will watch this story unfold from the sideline, and look for other candidates in the AI space, or wait for a better entry point for NVDA.

Stay safe, stay rookie and happy investing!

Nvidia, founded in 1993, specializes in the design and manufacture of graphics processing units (GPUs) for gaming and professional markets (like architects, engineers, game designers, scientists, and data analysts). Its primary product line, GeForce, is targeted at gamers and includes both desktop and laptop GPUs. Nvidia has also expanded its product offerings to include GPUs for professional visualization, data center, and automotive markets. In 2022, NVIDIA had a record-breaking year selling $27 billion but was almost flat compared to 2021.

Under the Compute & Networking segment ( 52% of rev. & grew 36%), NVIDIA provides data center platforms and systems for AI, high-performance computing (HPC), and accelerated computing workloads. This includes products such as Tesla GPUs, DGX systems, Drive for the Automotive segment and Mellanox networking solutions.

Under the Graphics segment (49% of rev. & decreased 25%), NVIDIA provides GPUs for gaming PCs and consoles, as well as professional visualization solutions for industries such as architecture, engineering, media, and entertainment. This includes products such as GeForce GPUs, Quadro GPUs, and RTX technology.

In addition to hardware sales, NVIDIA also generates revenue from software licensing fees for its CUDA parallel computing platform and other software tools  (used by almost 3  m .8 million developers worldwide). The company also offers consulting services to help customers optimize their use of NVIDIA's technology in their applications.

Nvidia's Position in the AI Market

GPUs are at the center of the AI transformation because of their parallel processing capabilities and ability to handle large amounts of data, much more adapted to run AI models than traditional CPUs. The NVIDIA Tesla series for example is currently considered one of the best GPUs for running AI models.

Nvidia enjoys a dominant position in the GPU market, with a market share of around 80% in the discrete desktop GPU segment. Its main competitor, Advanced Micro Devices (AMD), holds the remaining market share. This duopolistic market structure has allowed Nvidia to maintain strong pricing power and high margins.

Furthermore, Nvidia has made its hardware much stickier thanks to an end-to-end platform for AI and machine learning called Nvidia AI, which combines hardware, software, libraries, and tools to enable developers and businesses to harness the power of AI.

As AI and machine learning continue to permeate various industries, from healthcare and finance to manufacturing and transportation, Nvidia stands to benefit greatly from this growing market. According to a report by Grand View Research, the global AI market is expected to grow at a compound annual growth rate (CAGR) of 40.2% from 2021 to 2028, reaching a market size of $997.8 billion by 2028.

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Why did Nvidia´s net incomes plummet in 2022?

NVIDIA's gross margin fell in the fiscal year ending in Jan. 2023 because they had to write off a lot of inventory. They recorded $2.17 billion of inventory provisions, which means they had too much supply of their products compared to the demand, especially in China impacted by COVID´s restrictions. This led to a decrease in gross margin because they had to write off some inventory. The overall effect on NVIDIA's gross margin was an unfavorable impact of 7.5%.

Plus, capital expenditures (capex) for fiscal year 2023 jumped $850 million (+87%)  due to investments in property and equipment related to NVIDIA's data center and infrastructure expansion. This includes investments in new facilities, equipment, and infrastructure to support the growth of NVIDIA's data center business. NVIDIA expects its capex to continue to increase in the future as it invests in expanding its data center business and other growth opportunities.

Finally, their R&D expenses were +31% higher (+$2.3 billion)

Risks and Challenges Facing Nvidia

Firstly, competition in the GPU market is intensifying. AMD has been aggressively investing in its GPU technology, and its recent product launches have received positive reviews from customers and industry experts alike. Furthermore, Intel, the world's largest semiconductor company, has announced plans to enter the discrete GPU market, potentially posing a threat to Nvidia's market share and pricing power.

Secondly, Nvidia's success in the AI market has attracted the attention of both established technology companies and startups. Companies like Google, Amazon, and Apple have been investing heavily in their AI capabilities, developing custom AI hardware and software solutions. Additionally, a plethora of AI-focused startups, such as Graphcore and Cerebras Systems, are working on next-generation AI chips, aiming to challenge Nvidia's dominance in this space.

Finally, Nvidia is subject to risks associated with the cyclical nature of the semiconductor industry, which can be influenced by factors such as economic cycles, inventory levels, and technological advancements. Additionally, Nvidia's reliance on third-party foundries for manufacturing its chips exposes the company to supply chain risks, including capacity constraints, production delays, and quality issues.

Evaluating NVDA's Stock Valuation and Forecast: the bull case

Growth forecast

NVIDIA will maintain its leadership in the GPU market for artificial intelligence (AI) technology and the demand will grow exponentially from a wide range of industries. In this scenario, we trust Nvidia´s numbers shared in the transcript of the Fiscal Q4 2023 when the CEO mentioned that the TAM was $300 billion for hardware and $300 billion for software. In this scenario, we forecast that Nvidia will grow to half of this $600 billion opportunity by 2033. By then it will have around 10 million developers using its enterprise solutions with an ARPU of $22k (up from an estimated $3.5k today), and 350 million gamers with an ARPU of $323 (down from an estimated $539 today as more gamers migrate to the cheaper Cloud gaming sub).

Profitability forecast

The company will maintain its strong track record of innovation to maintain a competitive edge, increasing its pricing power and network effects. Nvidia is exploring new products in about every field you can think of, from Maxine & Broadcast for live audio and video optimization, Canvas for digital drawing AI augmentation,  Shield TV for Media Streaming augmentation on TVs, Bionemo for drug discovery (powering open-sourced models such as Google´s AlphaFold), Merlin for recommendation engines, Isaac for Robotics, Aerial or Telcom, Metropolis for Video analysis, RAPIDS for data analysis, Omniverse for AR/VR apps, Riva for conversation and speech processing, and many more. It is hard to keep track of all their announcements. A few days ago they released a demo of their "text-to-video" generative AI program, which seems powerful. Most of these software are free to use but require Nvidia hardware to work. As a consequence, NVIDIA's operating margins will grow to 58% (from 33% today).

A Cautionary Tale: The Bear Case for NVDA

Growth forecast

The company will grow to 17% of the $600 billion opportunity, tripling in revenues by 2033. By then, it will have more than 6 million developers using its enterprise solutions with an ARPU of around $11k, and more than 100 million gamers worldwide clocking a $323 ARPU.

Profitability forecast

NVIDIA operates in a highly competitive industry with rapidly changing technology and customer preferences. Plus, it is subject to significant regulatory and legal risks, including intellectual property disputes and antitrust investigations. NVIDIA's operations are also subject to significant supply chain risks, including disruptions in the supply of key components or materials as it depends on the foundry to manufacture their GPUs and could fail from grace with their Chinese customers. The competitive, legal, and supply chain constraints will force them to ever increase their R&D expenses and CAPEX in things like data centers to provide its Geforce Now cloud gaming services. This will put pressure on operating margins which will stabilize close to current levels at 35%.

Conclusion: Making an Informed Decision on Nvidia Investment

Nvidia's stock has performed impressively in recent years, delivering a whopping +89% year-to-day as of April 24th, and 108% since I first recommended it in October 2020. But after averaging the bull and bear case detailed above, and evaluating the outcome with a traditional DCF model (link to the detailed model spreadsheet), I come to the conclusion that Nvidia is about 44% overvalued, with too much growth and high margins expectation built-in current price levels.

From this level, I would not expect a market-beating return from an investment in Nvidia today, looking at the next 10 years. In fact, a reverse DCF suggests that Nvidia would need to grow its Free Cash Flow at a 80% CAGR for the next 5 years to justify its current $270 price, which is insane (Analysts forecast it to grow 27% 5Y CAGR). I am closing all my NVDA position. I love the company, but not its price. I could be probably wrong, time will tell. If you seek exposure to the burgeoning AI market, I would suggest looking elsewhere.

Ultimately, the decision to invest in Nvidia should be based on a thorough assessment of your investment goals, risk tolerance, and the company's prospects. As with any investment, it's essential to conduct your research and consult with a financial advisor before making a decision.

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Rookie Scorecard for NVDA: 9.5 out of 26, in the lowest half of my watchlist

Network effect: 2/2

One example of Nvidia's network effects is its CUDA platform. As more developers use CUDA to develop applications that run on Nvidia GPUs, it creates a larger ecosystem of applications that can leverage the power of Nvidia's hardware. This makes it more attractive for other developers to use CUDA since they can tap into this existing ecosystem of applications and tools. 

Another example is Nvidia's gaming business. As more gamers adopt Nvidia's graphics cards for their gaming PCs, it creates a larger user base that game developers can target with their games. This makes it more attractive for game developers to optimize their games for Nvidia's hardware since they know there is a large user base that can benefit from those optimizations.

Switching costs and price premium: 1/2

For Nvidia's customers in the gaming market, switching costs may be relatively low since there are several other companies that offer similar products such as AMD and Intel. However, for customers in the data center market who have invested heavily in Nvidia's GPUs and software tools such as CUDA, switching costs may be higher due to the need to retrain employees on new systems and workflows.
CUDA is free to use and there are around 3 million developers already using it. To use CUDA, developers need to have an Nvidia GPU installed on their computer or server.

Revenue Quality: 1/2

Most personal GPUs are sold as one-offs. However, in the data center market, enterprise customers may be sold through long-term contracts. In the gaming market, Nvidia's GeForce NOW cloud gaming service operates on a subscription model where users pay a monthly fee to access games on Nvidia's servers. This provides a recurring revenue stream for Nvidia as long as users continue to subscribe to the service.

Profitability: 1/3

While Nvidia's operating margin is extremely sound at 20.8% and better than the semiconductor industry, it has been on the decline over the past 5 years.

Barriers to entry: 0.5/1

One of the main barriers to entry in Nvidia's markets is the high cost of research and development (R&D) required to develop advanced GPUs and software tools. Nvidia invests heavily in R&D to develop new products and technologies that can meet the demands of its customers. This requires significant financial resources and technical expertise that may be difficult for new entrants to replicate. 

Intangibles: 1/2

The strong brand recognition that Nvidia has built over the years. Nvidia is a well-known brand in the GPU market, with a reputation for high-quality products and innovative technologies. This brand recognition can make it difficult for new entrants to gain traction with customers who may be more likely to stick with established brands like Nvidia. In addition, Nvidia has developed strong relationships with key customers in its target markets such as data center operators, game developers, and automotive manufacturers. These relationships can provide a competitive advantage, a bit like Microsoft with their Office licenses.

Future Growth: 3/3

NVIDIA is forecasted by analysts to grow revenues by 21% per year for the next 5 years. In my own valuation, I went more aggressive, and the average between my bear and bull case put the next 5 years revenues CAGR to 31%.

Concentration in either clients or products: -1/-2 

While no customers account for more than 10% of its revenues, they do depend on Amazon Web Services (AWS), Microsoft Azure, and Google Cloud Platform for their data center business. If one or more of these customers were to reduce their purchases from Nvidia or switch to a competitor's products, it could have a significant impact on Nvidia's revenues. These behemoths are customers and competitors, as they all develop their own custom chips and solutions that compete with Nvidia's offerings in the accelerated computing market. There are some perverse incentives at play.

Capital allocation Health: 0/1

Ok, $13 billion in cash, but not phenomenal. Overall it fares 7 out of 10 in GuruFocus "Financial Strength" composite index.

Resilience: 1/1

It did generate profit for each of the past 10 years, so kudos.

Value creation Track Record: 1/3

Nvidia has been growing its free cash flow at a 13% annual rate in the past 5 years, however, it has decreased by 4% in the past 3 years.

Exposure to economic cycles: -1/-2 

Definitely, semiconductors is usually a cyclical industry, but the fact that they made record revenues in 2022 while inflation was sky high and the stock market plummeted shows it has some resilience to face the economic cycles.

Other macro risks: -2/-2. 

Nvidia's revenue from China (including Hong Kong) was $5.8 billion for the fiscal year ending January 30, 2022. This represents approximately 21% of Nvidia's total revenue for that fiscal year. As the AI race between China and the US intensifies, I would not be surprised to see these revenues get wiped out. In fact, some of Nvidia´s most advanced GPUs have already been banned in 2022 for export to China by the US government.

Company´s management Grit (mix of passion and perseverance): 2/3

Insiders own approx. 4% of the company, not too shabby but not great either. The company mission "accelerate the world's transition to artificial intelligence" is dope, people seem to be happy to work there (according to tp Glassdoor) and the founder is still in charge.

Smart money signals: 0/4 

More hedge funds have been selling than buying during Q4 2022, no insiders have been buying lately as of April 2022 and Analysts' target is less than 20% above the current price. Nothing to see here.

Disclaimer

 The Rookie Investor recommends DOCU. The Rookie Investor has a disclosure policy. This article by The Rookie Investor is not financial advice as it does not take into account your objectives or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

What happened during the $SIVB (SVB Financial Group) run in 2023 serves as a reminder not to be over-exposed to any single financial institution. Without government intervention, those with more than $250.000 in their account could have lost everything above such an amount.

But what about my trading platform? Is eToro safe🕵️‍?

The amount of protection you receive depends on your account's jurisdiction and access to real stock assets instead of CFDs. Here's what you need to know to safeguard your investments.

I have been investing in eToro since 2010, they are not new, but my funds have been growing to a significant number so, how much of this is guaranteed? My account is Chile-based and under Cyprus jurisdiction. It means 2 things:

 📌 First, I now only have access to CFDs contracts, so no actual companies papers (aka stocks) are under my name and everything I invest in is owned by eToro.

 📌 Second: if eToro happened to fail and go bankrupt, the Cyprus authorities guarantee up to 20.000 Euros. After which I am on my own 💸. If you have access to real stocks instead of CFDs, these are real assets bought under your name by Etoro. You even have voting rights. In this case, if eToro goes burst, you should not have too much trouble transferring your stocks to another broker (even though the fact they don´t currently let you do that adds some uncertainty). If your account is under UK jurisdiction, the guarantee goes up to 85.000 GBL. Here is the official eToro doc link for more details.

What about eToro Additional Funds Insurance of 1 Million Euros?

Update from May 2023: eToro contacted me to note that Platinum+ and Diamond's customers are covered by additional insurance as promoted on their webpage. But the devil is in the details. Here is what they promote:

The free insurance is only available for Platinum + and Diamond Club customers of eToro (Europe) Ltd. and eToro AUS Capital Limited suffering losses due to the unlikely event of eToro’s insolvency and in case of an Event of Misconduct (as defined in the applicable policy). The insurance covers (i) up to 1 million euros or AUD (depending on the regulated entity), (ii) up to the aggregate limit purchased by eToro; and (iii) subject to an excess amount (as defined per applicable policy). The insurance covers cash, all CFD positions, and securities. Note that REAL cryptocurrency positions are not covered by this insurance, as set in the applicable policy

The link provided is not the actual policy but a summary of it. After a few back and forths with eToro support, I finally got my hand on the full policy document. Here is what I learned.

📌  The maximum aggregate amount payable by the Insurer to the Insured in respect of all Claimants' Net Losses is USD 10,000,000. It means that if eToro goes bankrupt, and the aggregated funds from Platinum+ and Diamond member is more than 10 Million AUD, you are not getting all of your money back. You need at least 50k USD to be Platinum+, so let´s say Platimum+ & Diamond members have an average of 75k USD in their account, then the guarantee would only cover 133 customers in each jurisdiction, 182 if I consider the basic Cyprus guarantee of 20k Euros.... which seems too low.

📌 There is a "retention" of 20k, so you are sure to lose at least 20k USD over the Cyprus basic guarantee of 20k euros.

📌 In respect of open contracts (such as options for futures contracts and CFDs), this Policy will only cover the collateral put up by Claimants to support such open contracts and not the value of the open position. It means if you have a multi-bagger position (like you bought AAPL CFD position 10 years ago), the insurance only covers what you have put as your initial amount when you opened the position.

Conclusion

𝙄𝙣 𝙨𝙝𝙤𝙧𝙩, 𝙞𝙛 𝙮𝙤𝙪 𝙝𝙖𝙫𝙚 𝙢𝙤𝙧𝙚 𝙩𝙝𝙖𝙣 𝟮𝟬.𝟬𝟬𝟬 𝙀𝙐𝙍 𝙞𝙣 𝙮𝙤𝙪𝙧 𝙚𝙏𝙤𝙧𝙤 𝙖𝙘𝙘𝙤𝙪𝙣𝙩 𝙖𝙣𝙙 𝙤𝙣𝙡𝙮 𝙗𝙪𝙮 𝘾𝙁𝘿𝙨, 𝙮𝙤𝙪 𝙨𝙝𝙤𝙪𝙡𝙙 𝙗𝙚 𝙬𝙤𝙧𝙧𝙞𝙚𝙙 (think of splitting your funds across multiple brokers). 😟 Everybody should do the same check with their financial service providers, including their banks.

My eToro portfolio took a big hit of -36% in 2022. Could have been worse if it was not for my short position on the SPY and some Gold holdings.

Cause

Inflation rates not seen since the late 1970s and early 1980s. The FED working to clean up the mess caused by easy money policies for too long. FED is in a campaign to throttle inflation by boosting borrowing costs.

And effect

Future cash flow is less valuable in a high interest-rate world. It costs more to borrow to fund growth. The bigger the growth rate, the harder/costlier it gets. Investors got it, and the Market shifted from growth stocks to value stocks. My eToro portfolio is 70%+ invested in growth-kinda stocks. Just check at how VTV outperformed VUG over the 3-months, 1-year and 3-years windows.

The question is: is the shift toward value and fixed income over or just starting?

Investing in 2023: opportunities and risks according to the experts

The optimistic team

BofA Global Research:

• Bullish on bonds in H1, stocks in H2.

• Forecast recession in H1.

• Past peak in interest rates, a trough in corporate profits by mid-2023.

• Balanced portfolio of 60% stocks and 40% bonds for positive return in 2023.

• Small-cap stocks are a great way to approach economic recovery.

Goldman Sachs:

• Markets often fall in anticipation of bad news but begin recovering even as the headlines remain ominous. Never has been a recession so much annunciated by economists (61% probability of recession according to 77 economists surveyed by the WSJ in Jan. 2023). Hence risk assets might deliver attractive returns if US recession is avoided.

• If a small recession happens, stocks could still deliver positive returns. There is a history of sizable rallies in the final months of past economic downturns.

• The slower pace of US dollar appreciation in 2023 could also help ease pressure on corporate revenues.

• Rising interest expense not a key concern this year, as most S&P 500 firms' debt is fixed over long durations.

J.P. Morgan:

• Challenging year for equity markets. Mild recession and contracting labor market predicted.

• Weaker demand and pricing power. Further margins compression. Less buy-backs. Hence lower earnings for companies.

• FED expected to change direction by year end. This should boost the S&P500 in the second half of the year.

• Focus on companies with lower debt and strong balance sheets to navigate the potential downturn.

Fidelity:

• Too much negativity in the market. Too late to be bearish, stay the course in equities.

• Focus on specific areas with historically low valuations. Valuation spreads—which measure the difference in valuation between the most-expensive and least-expensive stocks—looked historically wide at the end of 2022.

ARK Invest:

• 2022 market dislocation that crushed growth stocks presents an opportunity for innovation strategies to thrive when equity markets recover.

• Balance your portfolio with exposure to disruptive innovation. Hedge against the increasing risk of incumbents being disrupted.

The pessimistic team

Morgan Stanley:

• Unattractive valuations and lofty earnings expectations.

• No durable recovery in U.S. equities in the year ahead

• Focus on fixed income to wait for better opportunities further down the road.

• Opportunities to be found in Asia and Latin America stock markets. They are trading cheaply relative to their history and developed market equities.

GMO:

• Expects low returns for most asset classes in the coming years.

• Advises investors to focus on defensive strategies and avoid chasing high-growth sectors. Focus on "deep value" instead.

• Think longer term. An aging population means a lack of workers. Climate change and hot geopolitics mean more supply chain disruption. The lack of metals needed for decarbonization means soaring commodity prices. All of this will drag on growth and keep boosting inflation.

Blackrock:

• New regime of greater economic and market volatility is playing out and not going away.

• Expect inflation to cool but stay persistently higher than central bank targets of 2%.

• Focus on sectors, regions and sub-asset classes, rather than broad exposures.

The Economist:

• US stock market still expensive by historical standards relative to their underlying earnings.

• Growth and value stocks both vulnerable to earnings downgrades.

• End of the free money era. Governments need more private investors to hold their debt now and in the future. It will drive bond prices down and yields up, making stocks less attractive.

• Divergence of expectations between economists and investors. Earning downgrades still to materialize. Analysts´ consensus still forecasts earning growth of 4% in 2023, while 2/3 of economists forecast a 2023 recession.

• Divergence of expectations between the FED and investors. Markets expect the Fed's benchmark rate to hit a peak of below 5% in the first half of this year, before declining. The central bank's governors disagree. They project that the interest rate will peak at 6%.

• More pain ahead for investors in the stock market.

My game plan for 2023

Navigating the stock market in 2023 will be a challenging task. Experts have varying opinions on the opportunities and risks that lie ahead. Some experts are optimistic about the market and recommend a balanced portfolio of stocks and bonds for a positive return. Others advise investors to focus on fixed income and avoid chasing high-growth sectors, while most recommend focusing on specific areas with historically low valuations.

My key takeaway from this analysis is to be extra cautious on the short and long term. GMO makes good points about why long-term prospects do not look too good. Given I am investing to retire by 2030, it strikes a cord.

About 50% of my cashflow goes to real estate in Chile (paying the mortgage). 25% is going to a pension plan primarily invested in the global stock market. What´s left is what I can choose to invest with greater flexibility in my eToro portfolio or elsewhere. This 2023, I will definitely invest any extra savings in local fixed income, which currently yields very safe double digits (inflation in Chile is running at 13%).

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I do have a significant amount invested in US equities through eToro. I won´t add to it in 2023, nor will I sell it. I will stay the course. My scorecard already helped me focus on companies with lower debt and strong balance sheets, and I will keep exposed to companies addressing long-term challenges such as climate change and resource shortages. The Rookie Investor scorecard, combined with detailed valuation scenarios, will guide me in deciding which positions to close, and which to add to, but do not expect significant changes to my portfolio.

I also keep my 3.5% Gold, 4% Bitcoin and 20% Short SPY positions untouched to give me some quick dry powder in case the market turns sour.

If the S&P500 fall below 3700, I will close my short SPY and add to my highest conviction stock positions. If it goes the other way and investors get too excited, I will consider selling my lowest conviction stocks and add to my short position of the S&P500 or the more Tech heavy QQQ ($PSQ was added recently to eToro) to better hedge against my current holdings profile. Too excited for me would be seeing the SPY climb past 4100.

Be prepared for more volatility.

Disclaimer

The Rookie Investor has a disclosure policy. This article by The Rookie Investor is not financial advice as it does not consider your objectives or financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Our analysis may not factor in the latest price-sensitive company announcements or qualitative material. eToro is a multi-asset platform that offers to invest in stocks and crypto assets, as well as trading CFD assets. Please note that CFDs are complex instruments with a high risk of losing money rapidly due to leverage. 67% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to risk losing your money.

Have feedback on this article? Concerned about the content? Get in touch with us directly.

Adobe's business primarily sells specialized software subscriptions for the creative professional community (photographers, video editors, graphic/experience designers and game developers). It includes the famous Photoshop, Illustrator, Indesign, Premiere, a 3D/VR design suite called "Substance" and many more (they have over 20 products in this category). This niche, which they call "Creative Cloud" represents 61% of its total revenues. The rest comprises its "Document Cloud" (12% of its revenue, includes Acrobat and Adobe Sign) and its suite of "Digital Experience" software aimed at marketers to create, manage, execute, measure, monetize and optimize customer experiences (24% of its revenues, including Magento, Marketo, Analytics/Omniture and more).

Adobe bull case story

Adobe products are the essential toolkit for any creative amateur and professional. It has been successfully transitioning to a subscription business model where all its product suites complement each other in an unbeatable net of cross-selling opportunities for current and future creative professionals.

There is no serious alternative for this niche, and the number of professional creators subscribing to Adobe cloud has been growing at a 17% annual rate since 2017. There is no reason for it to slow below 12% in the next 10 years to reach 100 million paid subscribers, as the rise of the creator economy only strengthens the demand for design services and creators in general. Then there is the much-hyped “metaverse” of interconnected virtual worlds, which will be full of digital objects Adobe’s tools help build.

Its growing suite of solutions for marketing professionals fits nicely with its design solutions, as designers and marketers usually work closely together in the corporate world. This way, Adobe multiplies its go-to-market strategy and entry point into the enterprise to make itself more indispensable by the day. The fact that its suite of design and marketing products are working better together builds up its organic growth potential, besides strengthening its pricing power. Its average ARPU growth per customer should accelerate from its current 5% rate to at least 7% per year.

Adobe bear case story

The creators' economy is built on self-funded entrepreneurs with low budgets who have been keen to skip the professional designer fee to produce their simple design materials thanks to platforms like Canva or the same Adobe Express.

Canva has been growing at an astonishing rate and has at least 10x more unique users than Adobe Express, and 7x more than Behance.net (Adobe Designer Social Media platform), according to SimilarWeb data. It means the demand for designers may not be accelerating in the future; quite the contrary.

Plus, there is a growing offering of AI tools (Midjourney, DALL-E) able to transform a text prompt into a state-of-the-art picture or design, which could replace many basic human tasks in the design process. Adobe has integrated some of this tech in its "sensei" AI within its product suite.

Adobe has already penetrated 47% of the 68 million total addressable creative pro market (estimated by Adobe themselves). Adobe could reach 52 million paying subscribers by 2032, which means its user base would slow its growth to 5% per year. As competitions for lower-priced tools intensify, so does Adobe's ability to grow its ARPU, hence depressing its gross margins. The fact it has to maintain literally 50+ different software makes economies of scale less obvious.

On the marketing professional side, it is competing with behemoths like Salesforce, Google and Microsoft, who have quickly expanded their cloud services and industry-specific go-to-market strategies. For example, Google offers a "cloud for marketing" suite to bridge the value gap between web measurement leader Google analytics, CRMs and "know your customers" data lakes, also known as CDP. These formidable competitors far outpace Adobe in terms of sales team scale. Maintaining its market share will prove to be a difficult task.

Adobe Rookie Scorecard

Network effect: 2/2

Adobe's value proposition increases and marginal cost decreases as it swallows new products such as Figma, Marketo, Substance and more. The more its product ecosystem work closely together, the more it increases its organic cross-selling capabilities and decreases the cost of serving new customers.

Switching costs and price premium: 1.5/2

Try learning to use Adobe Illustrator or any of its professional tools, and you will understand why switching to another software is a pain. Plus, most design pros send their work in Adobe formats, so you need Adobe software to open it.

Revenue Quality: 2/2

Recurring monthly subs purchases with short repurchase cycles and long-term commitments for its enterprise solutions.

Profitability: 3/3

Its 34% operating margin is astonishing, expanding, and much better than most of its competitors.

Barriers to entry: 0/1

Nothing I can think of

Intangibles: 1/2

According to Interbrand 2022 ranking, Adobe's brand is in the top 25 of the world's most valuable brands.

Future Growth: 1.5/3

Adobe has entered many new niches, such as 3D and game design, document e-signing, e-commerce platforms and cloud data management. However, most of this "innovation" happened through acquisitions instead of internal capacity, which makes such growth more expansive with lower returns (i am looking at you Figma 20 B$ bill)

Capital allocation Health: 1/1

Very sound balance sheet management, Summed up by GuruFocus Financial Strenght Score

Concentration in either clients or products: 0/-2

No client represents more than 10% of its revenues, and 40+% come from outside the US.

Resilience: 1/1

It produced profits in each of the past 10 years.

Value creation Track Record: 3/3

Despite the challenging macro environment, it has expanded its free cash flow at a 24% annual rate over the past 5 years and 10% over the past 12 months.

Exposure to economic cycles: -1/-2

Professional tools are still needed if you want a job. However, if enterprise customers trim their workforce, it can mean fewer licenses to pay to Adobe.

Other macro risks: -1/-2.

I rest a point here because of the rise of self-serving design tools such as Canva coupled with image generation AI, which represents a threat to Adobe's core demand.

Company´s management Grit (mix of passion and perseverance): 1/3

Adobe´s Glassdoor rating is very high, one of its founders is still on the board, and its mission "help people imagine, design, and create a better world" is dope, but insiders own less than 1% of the company.

Smart money signals: 2/4

About as many hedge funds opened new positions as there were closing positions in the last quarter. Analysts´ mean target is just 14% higher than the current price, but there was insider buying last September from both a director and the CFO. I love it when the CFO believes in their employer by buying shares.

Is it a good time to buy Adobe Stock (ADBE) now?

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Averaging the bull and bear case I explained earlier, I forecast total revenues of $63 Bn. 10 years from now, with a stable operating margin. You can access to full DCF model for ADBE share fair price here. I get to a value close to the current price, into the single-digit overvaluation.

Given Adobe's robust scorecard (top 10% of my watchlist with 16 points), its current valuation is compelling if you closely monitor their revenue growth rate in the next few years. The company has repeatedly proved that it can prosper by embracing change rather than fighting it. I would worry if its growth slowed to the single digit. I am also assuming its operating margins remain stable over the year. If it drops, it would be another cause for concern.

Last but not least, Adobe announced its intention to acquire Figma, a fast-growing software design tool market competitor, in September 2021 for $20 billion. The deal has raised concerns among investors and analysts, with 53% currently rating Adobe shares as a buy compared to 80% before the announcement. Regulators are closely examining the acquisition, but Adobe remains confident it will close the transaction in 2023. Some analysts have expressed skepticism about the deal, while others find it more exciting and call Figma "less of a direct competitor of Adobe and more of a multifaceted opportunity."

My take is that Adobe has a lot of experience making acquisitions successful, and it will make sense 10 years from now, whatever Figma price tag is today. So yes, I think Adobe is a good company to invest in right now if you are in for the long term and don´t put all your eggs in the same basket.

Disclaimer

The author of this post owns shares of ADBE. The Rookie Investor recommends ADBE. The Rookie Investor has a disclosure policy. This article by The Rookie Investor is not financial advice as it does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Our analysis may not factor in the latest price-sensitive company announcements or qualitative material. eToro is a multi-asset platform that offers investing in stocks and cryptoassets, as well as trading CFD assets. Please note that CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 67% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.

Have feedback on this article? Concerned about the content? Get in touch with us directly.

The market sentiment index measures individual investors' feelings, or expectations, as surveyed by the American Association of Individual Investors (AAII). Bears are people who believe in doomsaying stories (aka the market will go down further). Bulls prefer stories with a happy ending (aka the market will go up). AAII published data goes back de 1987, making it a nice dataset to play with.

What is the Bull/Bear ratio?

The bull/bear ratio is the same as the market sentiment index, although a bit more specific. Indeed you can measure market sentiment by either looking at the single ratio of how many surveyed investors are optimistic (aka bullish ratio), or you can put it relatively to the ratio of pessimistic investors (aka Bull/Bear ratio). I found out in my own simulation that the single Bullish ratio was a better indicator than the Bull/Bear ratio as long as I averaged it over 8 weeks and you invested with a long-term timeframe (at least 8 years).

What is the current market sentiment?

Here is the weekly updated chart of the market, or individual investors, sentiment.

American Association of Individual Investors (AAII) vs. Investors Intelligence sentiment

The Investors Intelligence Bull/Bear Ratio is a sentiment metric focusing on US professional market advisors rather than individual investors. They provide a sample chart to the public but have a paywall to access the underlying data.

The American Association of Individual Investors (AAII) instead is an online survey any individual investor member of the association can take. Technically you don´t have to be a US investor to take it, but it still focuses on the US market.

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Is the individual investors´ sentiment a good indicator?

Pundits refer to these sentiment metrics as "contrarian" indicators. It's a fancy way to put what is also known as Warren Buffets' most famous quote: "be fearful when others are greedy, and greedy when others are fearful." Another way to put it is to go back to what a market is in its essence: a demand vs offer problem. If very few people think the market will go up, then the demand for buying assets is low, hence depressing prices.

As a result of greed, prices typically rise. An overpaying buyer might end up with an asset that provides weak returns. Hence, a good investment opportunity may arise when others are fearful. But is it really? I had to run a few simulations to check this supposed market wisdom. It turns out that buying while the fear is high (bullish ratio 8 weeks moving average under 27%) AND the market is in bear territory beats the "invest every month no matter what" scenario by an average of 9.1x! However, it was not such a good indicator if your investing time horizon is less than 8 years. Check here the complete analysis.

What is the level of market fear, also known as the "market fear index"?

The fear index is just another way to refer to the market sentiment, but if it focuses on its pessimistic side? The fear is high when the bullish ratio gets below one standard deviation from its mean. In the case of the AAII bullish ratio, that would be below 28%, or below 30% if you average it over 8 weeks.

What is the maximum level of drawdown seen on records from high fear levels?

When the 8-week average bullish ratio is 1 standard deviation below its mean (below 30%), the maximum subsequent drawdown from these levels (measured as the weekly close price of the S&P500) on records is -46%. The maximum drawdown occurred back in May 2009, almost a year after the bullish ratio 8 wks avg had crossed the 30% mark in June 2008. However, from the 17 times this ratio went into the fear zone, the mean drawdown from there was -11%, with a std. deviation of 10 percentage points.

When the 8 wks avg bullish ratio crosses 2 std deviations down (below 22%), it never went further down more than -12%, which happened once in the 1990s.

I went to Buenos Aires a few weeks ago and had a lovely time eating delicious food and walking down its beautiful streets. But there was an awkward experience you can only live in very few countries: tourists do not use their credit cards because the official exchange rate is about double the non-official one, also known as "dólar blue". Most Argentinians try to save in USD as the Argentinian Peso is experiencing a 70% inflation rate, and they even publish real estate prices in USD. But, their central bank is short on the green note, and the local Government makes it hard for nationals to buy USD. Hence the abusive official exchange rate and a limit on how much USD you can buy, even when Argentinians use their credit cards overseas. Now imagine you are Uber, and you need to send payments to Argentinian drivers abroad; How do you navigate these Kafkian legal and tax systems? You call Dlocal to make it for you...

Surfing the digitalization of emerging economies - Dlocal Mission

Dlocal mission is to enable global merchants like Uber, Netflix, TikTok and so on to connect seamlessly with more than 2 billion internet users in emerging markets, both to "cash in" from and "cash out" to these markets. Argentina is just one of the 35 markets from Asia, Africa and Latin America Dlocal gives access through one API and contract. Besides promising a high acceptance rate from cash-in, they offer value-added services such as fraud prevention and tax compliance, which gives them higher product stickiness and average revenue per customer. If they can help with compliance matters in Argentina, I guess they have a heads up to replicate this know-how in about every corner of the world.

Dlocal value drivers

Dlocal Network effect: medium. Serving more customers, or helping one customer enter other emerging markets, decreases the marginal cost of servicing this emerging market. I guess Dlocal is not making a profit on the 35 needs it serves, but it eventually will. However, competitors such as Adyen have a broader customer base and services in developed economies such as Europe and North America, with more significant economies of scale already.

Dlocal Switching costs: medium. The operating impact of changing pay-ins and pay-outs channels for a business can be huge. If you add tax compliance and fraud detection to the mix, Dlocal gets stickier, and its customers are less likely to churn. According to Dlocal earning's call from Q3 2021, it translates into a churn rate below 1%. I just don't give this item a "high" rating because there is growing competition in the space, which can pressure its pricing power as customers may look for margin improvement.

Dlocal Revenue quality: High. It is recurring by design with long-term contracts and grows in sync with its customers' revenue from emerging markets.

Dlocal Profitability: Medium. This is a highly profitable business with operating margins sitting at 35%. Still, it is not expanding, their filling even talks about a possible decrease.

Dlocal Barriers to entry: high. Navigating regulatory, licensing, tax, integrations and operative specificities of 35 markets as diverse as Egypt, Turkey, Indonesia, Argentina, Brazil etc. must be a nightmare, which makes it a competitive advantage.

Dlocal Intangibles: medium. Even though its products are not patentable, it manages to delight its customers if their churn rate is so marginal. Their Argentinan DNA to creatively navigate all kinds of operative  & legal barriers also give them an intangible advantage.

Dlocal Future growth and optionality: high. They have multiple growth avenues like onboarding more customers (their current base is relatively small at 400 vs. 3500 for Adyen), helping their existing customers enter more markets, and upselling them more value-added services. They have proven they are quick to add new markets, new payment methods (a quick look at Adyen Payment methods in markets such as Nigeria, Philipinnes and Mexico shows that Dlocal has a broader set of payment methods integrated into each of those) and build new value-added services. Their latest innovation is a direct issuing product, which gives their customers a white label platform to issue debit cards to their clients.

Dlocal risks

Dlocal Client concentration: One client represents more than 10% of their revenue, but this concentration has decreased over time.

Dlocal Financials: There are no risks here, as they have almost no debt and are not far from being Free Cash Flow positive.

Geo-political and ecosystem risk: the most significant risk I see is their dependence on Card network's (Visa & Mastercard) policies. There is already friction in Chile, where Visa and Mastercard tried to change their commission scheme with Dlocal to be later blocked by the local free trade court. This intent could spread to other jurisdictions and significantly impact fees paid by Dlocal to Card Networks. Then there are geo-political risks because of the very nature of emerging markets with unstable institutions, hence regulations, which could negatively impact the Dlocal business model. This is why I  punished DLO margins by 10 percentage points in my bear case.

Dlocal Tax risk: Dlocal is based in the Cayman Islands are tax exempted company. It is unlikely this kind of loophole be accepted forever, and their current low effective tax rate of 9% should be impacted. I accounted for it in my valuation model.

Dlocal Valuation stories

Forecasting the next 10 years of growth of Dlocal

The current pace of new customer onboarding is 10 per month, with RFP processes that can take months to years. It means a 29% customer base growth considering churn. I modeled a lowering acquisition pace of 10% on average over the next 10 years in my bear case (to reach 1000 clients), and 20% in my bull case (to reach 2500 clients).

The average annual revenue per customer grew 64% in 2021 to reach USD 610.300 per customer. This growth will also depend on their clients' total processed payment volume in the emerging world. As per management comments: "the growth of our merchants that are some of the leading e-commerce typically growing from 20% to 30% annually in emerging markets". With a growing list of services and markets offered, I modeled an aggressive 25% average ARPU growth over 10 years in my bull case, and a more modest 7% growth in my bear case.

2032 projections BEAR Case BULL case Base Case (median) Implied subscribers growth 10% 18% number of merchants 1,037 2,094 1,566 avg new merchants per month 5.3 14.1 ARPU implied growth 7% 25% TOTAL annual ARPU per merchant $1,200,552 $5,683,862 $3,442,207 Total Revenues $1,2B $11,9B $6,6B Operating Margin 25.0% 35.0% 30.0%

Forecasting Dlocal Margins

To account for the above risks and commoditization of payments, I don't expect Dlocal to expand its margins. So the best-case scenario is that they manage to keep operating margins at current levels and drop to 25% operating margins by year 6 in my worst-case scenario.

Forecasting Dlocal Returns

This one is harder for me to forecast. The current sales-to-capital ratio (aka working capital turnover) sits at 1.0, which isn't great as every penny Dlocal makes needs to be reinvested to fund its growth. It is very early for Dlocal as they have been adding features at a crazy pace in the past few years, so I expect their sales to capital ratio to improve over the next 10 years. How much? is the trickier part of the equation. I input a ratio of 1.2 from year 6 onward, and the return on capital by year 10 would be 25%, not far from Adyen and Visa.

The boring stuff, aka cost of capital

To calculate the model's discount rate, or cost of capital, I used a risk-free rate of 3.75%, higher than today's 3.2%, because I expect it to keep rising in sync with the FED rate. The final cost of capital I used, including equity risk premium, is 11.5%

How good is Dlocal Management

Dlocal is a founder-led business. Insiders own approx. 45% of the equity, so a lot of skin in the game. However, its Glassdoor ratings have been dropping below 4 recently and should be carefully watched.

Is Dlocal a good investment right now in 2022?

Dlocal is an excellent but risky $8 Billion business. It fares just below the 10 points on the Rookie Investor scorecard, which is out of my comfort zone. In terms of valuation, I calculate a fair value of $32 per share in my base case. It is close to its market price and does not leave much safety margin as I write this. It is a hold for me, and I would consider adding to my position if it gets below $22, or selling if it gets higher than $42 within the next 12 months.

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You can download the complete Dlocal valuation model I used here and input your own numbers to see your estimated fair value for the stock.

What to watch in the subsequent earnings? The pace of new customer acquisition, the rate of ARPU growth and the operating margins levels. I look forward to evaluating other promising FinTechs such as Nu, Adyen and Marqeta to get a clearer picture of my favorite pick in this sector.

Fe de errata: in my latest Shopify valuation, I made a mistake on the number of options outstanding, which significantly impacted the final fair value I calculated. I corrected the model and changed my conclusion from Hold to Buy! Sorry for that.

Have you heard of Mr. Beast? If not, you may want to YouTube it (spoiler: he made a real-life "Squid Game"). I spend an unexplainably long time watching his videos each time I do and feel dumber afterward. Well, Mr. Beast is one of the biggest YouTube channels worldwide. He cashes in with his massive audience by selling them "Merch" through branded e-commerce. Guess who he chose to build it? Damn right, he went for Shopify, like approx. 3-5% of Small Businesses selling online worldwide (according to our estimate, more details in the attached valuation mode). It is also the e-commerce building platform growing the fastest.

Why? Shopify Value Proposition

Shopify leads market share and growth for a reason: enhanced by its scale, a superior value proposition creates a value flywheel that widens its moat over its competitors.

When I started my own e-commerce venture in 2018, I had the option to start from scratch or buy an existing store. If you choose the first option, you will probably want to take an online course on how to build e-commerces or watch Youtube videos explaining it to you. I did, and half of the first 10 videos suggested by Youtube show you a step-by-step process on... Shopify. Finally, I decided to go for the option of buying existing e-commerce. There are a few marketplaces to buy that kind of business online, and there is even one owned by Shopify itself called "Exchange Marketplace". At that time, I thought, "wow, if I want an easy exit alternative, getting access to this marketplace is a good one". That's when I decided to buy a Shopify e-commerce, not just e-commerce. Then you have :

• A polished UX with an easy, step-by-step, no-code,  process to have an up and running best in class e-commerce

• Hundred of thousands of website themes available.

• Thousands of developer extensions, enabling the native integration with about everything you can think of, from Google & Meta advertising channels to syncing with third parties marketplaces like Amazon, Walmart and most local players (like Shopee or MercadoLibre). It has just announced a partnership with Youtube as the first platform to sync with YouTube Channel creators to sell their products on what seems to be Google's "social commerce" play [updated on Aug 22].

• A smooth checkout experience with Shopify Payments

• Higher conversion rates for high ticket items thanks to the offering of a buy now pay later option.

• Native integration with shipping providers and faster deliveries with Shopify Fulfillment

• Working capital financing with Shopify Capital

• A new Checking account service with a debit card called Shopify Balance (I haven't tried it)

• They make it easier to sell abroad with their Global-E partnership through Shopify Markets.

• Exclusive access to a growing new sales channel called "SHOP", which is a Shopify-owned retail app growing pretty fast (it now has approx 18 million active users worldwide and is currently top 20 in the retail category for iPhone users)

It doesn't get any better than this as far as value proposition and moat are concerned. The more you grow your business and use these services, the harder it gets to churn. Shopify has massive network effects and switching costs. A hot, hot, potatoes then, but is it too hot to invest in?

Shopify Valuation Scenarios building

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You can download the spreadsheet template with the detailed DCF model used in this valuation

Forecasting the next 10 years of growth of Shopify

Shopify gets 29% of its revenue from subscriptions, which starts at 29 USD per month for the first tier and goes up to 2.000 USD for its enterprise solution. 2 million businesses from 175 countries pay this subscription as of December 2021, primarily small businesses. According to Statista's analysts (who combine Eurostat, ILO, OECD and Wordbank data), there were 212 million small businesses with less than 250 employees in 2020, and 28% of them sold through the Internet (Source: Euromonitor 2021). It means Shopify's share of the total addressable market is approx. 3.5%. I assumed the number of SMEs worldwide will grow at an average 2.5% annual rate until 2032 (it grew 2.8% in the past 20 years), and Euromonitor forecasts the percentage of it that will sell through the Internet will increase to 32%. This gets me to a total addressable market of 92 million SMEs in 10 years.

Estimated number of Small businesses in 2020 212,980,000 Last 20 years CAGR in small businesses 2.80% Next 10 years estimated CAGR 2.5% Number of Small Biz in 2032 286,434,422 Number of Biz selling through Internet in 2021 28% Number of Biz selling through Internet in 2032 32% Total potential Market in Merchants in 2032 91,659,015 Current number of merchants subscribed to Shopify 2,063,000 Merchant subscribed back in 2016 377,500 Subscribers CAGR L5Y 40% Current Shopify market share 3.5%

5 years ago, the average subscription price paid by Shopify´s merchants was $42 a month. Now it sits at $52, so it grew at a 5% average annual rate. In my bear case, I projected the average subscription price growth would slow a bit at 4%, while in the bull case, it would accelerate to 6%.

2032 projections BEAR Case BULL case Base Case (median) market share by 2032 4.00% 10% 7.00% number of merchants 3,666,361 9,165,901 6,416,131 Implied subscribers growth 5% 15% 11% avg subs fee next 10Y CAGR 4% 6% 5% avg subs fee by 2032 $83 $103 $93 Total Subs Anual Revenues (000) $3,672,512 $11,321,424 $7,496,968

The subscription business was its first business model, so the fact it gets 2/3 of its revenues from everything else means SHOP has a pretty good innovation and organic growth track record. Some of these ancillaries businesses are just starting, like the banking and buy now pay later for example. In 2021, the average ancillaries revenue Shopify got from its merchants was $132/month, up from $44 in 2016! It means it grew ancillary revenue by merchant at an impressive 24% annual rate.

2032 projections BEAR Case BULL case Base Case (median) avg ancillaries fee next 10Y CAGR 10% 18% 14% avg ancillaries fees by 2032 $377 $816 $596 Total Ancillaries Revenues (000) $16,578,291 $89,714,430 $53,146,360

My base case (median between the bull and bear cases) is that SHOP would sell $61 billion annually by 2032 to 6.5 million merchants. It implies growing subscribers by 11% annually (it grew 40% a year in the past 5) and average annual revenues per subs by 13% (it grew 17% in the past 5 years).

Forecasting Shopify margins

It means the tendency to get more income from its "enterprise" (bigger businesses) customers should intensify. It impacts the margins positively as the churn rate for these customers is much lower, and less gross margin is spent on acquiring new, smaller customers. 2021 operating margins sit at 16.5% (see the attached model for details on this calculation as I have capitalized research & development expenses). Still, analysts expect it to shrink to 2% in 2022 because of massive investments in their fulfillment centers and a change of policy with the third parties developers, who will now start paying commissions to Shopify from 1 million dollars in sales onward. The global software industry operating margins are approx. 20%, Amazon´s operating margin, the king of fulfillment centers, is just 10%. How much will Shopify venture into the last mile economy (it recently bought Deliverr to strengthen this approach) eat into margins, and for how long? I built a simple weighted average between the different lines of business based on their estimated revenue, using industry benchmarks as a guide, which gets me to a 13.2% target margin. That would be my bear case, given Shopify should do better than industry averages thanks to its pricing power. I end up with a 14% operating margin as my base case.

Business % of Revenues Avg Operating Margins Weighted Operating Margins Software (System & Application) 50.00% 19.82% 9.91% Financial Svcs. (Non-bank & Insurance) 20.00% 9.17% 1.83% Retail (Online) 30.00% 4.75% 1.43% Company 100.00% 13.17%

Forecasting Shopify returns on capital

Capital efficiency determines how much of the remaining operating income needs to be reinvested into the business to grow. This required reinvestment rate is then used to compute the return on invested capital (aka ROIC). I used the sales to capital ratio as a proxy to forecast the reinvestment rate. Shopify´s sales to capital in 2021 is 0.8, and Amazon´s is 1.6. I assumed the sales/capital to remain stable for the first 5 years, then converge toward a higher capital efficiency (1.5), thanks to the long-term investments Shopify is currently making on multiple fronts. It means Shopify has an average cost of capital of 8.8% and ROIC of 9%, peaking at 13% between years 7-9. I maintained a "cruise" ROIC of 11% in its "terminal year" because I believe Shopify moat is long-lasting.

The boring but essential stuff (aka Cost of Capital)

This is where assumptions are totally out of one´s control, as it is impossible to know where interest rates will be 5 or 10 years from now. I used a risk-free rate of 3.75% (today´s rate is 3.2% as I am writing this, but increasing each week), then fall back to 2% in the terminal year of the DCF model. It means I am punishing valuation by anticipating a long inflationary cycle.

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Is Shopify a good investment right now in 2002?

My base case consists of the average between my bear and bull case. It gets me to a Shopify fair price of $45 per share, which suggests it is 28% undervalued (update from Aug 27th) if you think my story makes sense. On top of that, SHOP scores 12.5 on the rookie scorecard, so for me, it´s a buy. What to watch in the subsequent earnings? The pace of merchants' subscription growth, the average price per subs, the average ancillaries revenues per merchant and the evolution of the operating margins in the next few years.

Disclaimer

The author of this post owns shares of SHOP. The Rookie Investor recommends SHOP. The Rookie Investor has a disclosure policy. This article by The Rookie Investor is not financial advice as it does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. eToro is a multi-asset platform that offers both investing in stocks and cryptoassets, as well as trading CFD assets. Please note that CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 67% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.

Have feedback on this article? Concerned about the content? Get in touch with us directly.

Everyone has a professor fondly remembered who made us love a field of study we would not have otherwise. Over the past year, I have experienced it again, but exclusively through YouTube! It is professor Aswath Damodaran from NY Stern University, and the field he teaches about is corporate valuation. Corporate valuation can be pretty sterile stuff to study, but he makes it fun. He teaches that corporate valuation is about storytelling and creativity as much as it is about number crunching.

And it seems there are very few things I enjoy more than these 2 things: creativity and data analysis. So I will share more of that newfound passion with you, starting with a thrilling practical exercise: valuing Tesla.

What happens when the valuation dean values Tesla - Is Tesla a value stock?

Aswath recently made its own detailed valuation of Tesla, providing all the source formulas and numbers he used. According to him, the fair value of Tesla would have been 571 USD back in Nov 2021, when the risk-free rate was around 1.5%. It is now at 3%, making Tesla’s fair value smaller at 481 USD. I would argue that he was forgiving when inputting Tesla’s cost of capital. He did not consider the stock’s huge Beta, which means greater volatility and should mean greater return expectations for the investors taking such a risk. According to Aswath’s own lecture on Beta’s importance for calculating the cost of capital, I used a much higher cost of capital at 15%, which means Aswath’s valuation story on Tesla would put a fair price of around 306 USD per share, less than half of today’s price.

What story does the professor tell about Tesla?

Enough with the boring part; what stories does the professor tells about Tesla?

With the wind behind its back, Tesla has consolidated its hold on the electric car market and will continue to grow that market at the expense of conventional car makers. As the crisis handicaps its more indebted, slower-moving competitors. Tesla will consolidate its hold on the electric car market and push its revenues to roughly $400 billion (about ten million cars, augmented by revenues from ancillary businesses) in 2032.

Here you have the first part of the story to input the future source of growth. According to industry forecasts, that would represent about 9% of worldwide car sales. The story makes sense if you consider almost every car sold will be electric by then. The biggest carmaker, Toyota, has a 10% market share today. However, Aswath does not tell a story where Tesla will make more than 10% of its revenues from autonomous ride-hailing services and other ancillaries.

It will also deliver higher margins than traditional auto companies in a steady state. It will remain an electric car company at its core. Its superior manufacturing efficiency and current excess capacity will boost its reinvestment efficiency to new records for the next 5 years.

This is the second part of the story, which focuses on profitability. The professor translates it to an operating margin of 16%, in the range of the best manufacturing firms (but far from the Software firms) and a sales-to-capital ratio of 4 to then fall back to its current level of 2.7. This would be close to the bear case in my valuation story as you will see.

Finally, on risk, Aswath used the typical US company’s cost of capital. The stock is almost exclusively financed through equity and has very low debt and a decent amount of cash. I instead added a risk premium to the cost of capital because of the historic high stock volatility compared to the S&P500.

What happens when Cathy Wood’s team values Tesla - Is Tesla a meme stock?

First, we need to recognize ARK analysis has some real substance: they are probably the only investment fund open sourcing their entire valuation model. I applaud such a disruptive approach. I went through their model in detail to understand what part of the story makes their valuation so crazy far away from the professor’s. How far away? ARK’s “base case” puts a $4.600 2026 target price, which means a 57% CAGR from Aswath’s price for the next 5 years, quite a stretch.

ARK’s story about Tesla software business

The first big difference in their story is that Tesla will be a software company at its core instead of an auto company. More than half of its revenues will come from auto sales, but 2/3 of the profits will come from new revenue streams (mostly autonomous and human ride-hailing). Their model uses Monte Carlo simulation, which means the final result of their price target is a statistically weighted average between thousands of scenarios that combines different input variables. Their assumptions are not one-sided, but rather a range of options they think are plausible, with a wider standard deviation if they are less sure about a specific variable. For example, their input on when their autonomous ride-hailing service will launch is a range between 2022 and 2030. But they force the upper and lower bound of the standard deviation to be between 2023 and 2026. Their mean revenue estimate for that business is 216 Billion USD by 2026. They forecast approx. 10% of the cumulative Tesla sold fleet would be added to the robotaxi network within a year of the launch, each traveling 110.000 miles on average, with a platform cut of 50%. These are a lot of assumptions, which is why the Monte Carlo simulation makes sense. Their bear case would actually not see any revenue from this robotaxi business, so why is their bear case valuation still so high?

ARK’s story about the Tesla Car business.

In terms of cars sold, their input is a segment penetration range for each model by 2026, and the range spread is vast. Their mean is 16 million units sold with a std deviation of around 12 million. It means they are concentrating their simulation in a range between 4 and 28 million units sold. The professor models 5 million units sold in 2026, closest to ARK’s worst scenario. The thing is, with the Monte-Carlo method, the average bear case either has some Autonomous ride-hailing business running or a higher volume of cars sold than 4 million units. This is why the average bear case for ARK has a 49% gross margin, much higher than today’s 29%, and similar to Ferrari’s gross margin. I wouldn’t call that a “pessimistic scenario”.

ARK ultimately ends up using multiples to value Tesla

There is a lot of research that backs ARK’s model to forecast TSLA fundamentals. But when translating it to a share price, they use multiples. Tough it is not the source of their overwhelming optimism about the stock, as they use a pretty conservative multiple for their car business (13 for the car business and 19 for the robotaxi business). Maybe I would be slightly more conservative on the robotaxi multiple, but it’s no-nonsense. Instead, the professor uses a discounted cash flow model using an estimated cost of capital based on the risk-free market rate and the Equity market risk premium. Anyway, both methods are approximative.

Conclusion

Valuation is fun but a very personal exercise. The more you go deep into others’ valuation models, the more you realize why you should do your own valuation before trusting others. Professor Aswath’s template is an excellent start to play with your own story. Here is the bear and bull story I built for myself.

Tesla bear case

I gave Tesla a 10% global market share by 2032, close to the Professor´s estimate. In this story, the business is still centered on car sales, not Sofware. I maintained its operating margin similar to its already high level compared to the industry (17%). But I also penalized its cost of capital for its high volatility relative to the S&P500, making equity investors demand more investment yield. With the professor discounted cash flow model, I get to an intrinsic value of $460. Link to the model

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Tesla bull case

In this story, Tesla makes 1/3 of its revenues from a hypothetical autonomous ride-hailing service 10 years from now, not far from Cathy Wood’s forecast, but further in time. It represents a $320 billion-a-year business. I calculated this assuming that

• 20% of the most recent 7-year sold fleet would be offered in the robotaxi service,

• The average cost per mile would be $0.6,

• Each car travels an average of 20 thousand miles a year in it.

• Tesla’s platform cut is 35%, with an operating margin of 28%, thus accounting for about half of Tesla´s profits.

• The cost of capital for Tesla is average compared to the market, at 8.5%.

Instead of running a Monte Carlo simulation and using EV/EBITDA multiples to translate it into a stock price, I used the simpler DCF model used by the professor. It gets me to an intrinsic value of $1.200, close to ARK´s bear case 2026 target price brought to 2021 present value with an 8.5% discount rate. Link to the model

Is Tesla a good investment right now in 2022?

There is a massive spread between my bull and bear case, and the average would put Tesla's fair price at $870. It means Tesla would be about 25% undervalued, as I am writing this. 25% is a decent safety margin when discussing more traditional, less volatile businesses than Tesla. But TSLA is not that kind of business and has a beta of over 2. I would expect at least twice the usual 20% safety margin. I know this would mean penalizing Tesla twice for its high volatility (once in the cost of capital of the bear case, once in the expected safety margin), so I am adjusting the cost of capital to 8.7% in the bear case to get an intrinsic value of $720. The new average case would then be $1.000: we have our 40% safety margin! So I do think Tesla looks good for high-risk-tolerant investors at $700. Keep in mind that even the bear case story is all about future growth, every misstep means huge volatility in the stock price. Ultimately, it also depends on how comfortable you are with Elon Musk´s style. In my case, I'm becoming increasingly uncomfortable with him since Twitter´s takeover news. I am for now staying on the sideline as I have too much volatility already built in my portfolio. Next on my valuation list: $NVDA (NVIDIA Corporation), stay tuned!

💡 If you wonder if now is a good time to invest in the stock market, beside TSLA in particular, I wrote this piece to answer this question by analyzing 35 years of investors´ sentiment.

Disclaimer

The Rookie Investor has a disclosure policy. This article by The Rookie Investor is not financial advice as it does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. eToro is a multi-asset platform that offers both investing in stocks and cryptoassets, as well as trading CFD assets. Please note that CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 67% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.

Have feedback on this article? Concerned about the content? Get in touch with us directly.

It's funny how humans pay close attention to stories over pure logical thinking. My day job's most crucial skill is storytelling, not the data analysis itself. You can make great analysis nobody will care about if you cannot tell a nice story to show it. Journalists have the same imperative, few people would read their articles if not for their capacity to make them memorable, hence attractive to the "right-brain". On May 20th, 2022, it was all about "the US entered the bear market territory," and a few hours later, the headlines were "Stock market rally out of the bear market".

Nonsense, the primary US index was down by 19%. Why would one percentage point matter? It actually does because investors are as sensible to stories as everyone else. This is why I am paying close attention to a market sentiment metric called the "bullish ratio". The bullish ratio is based on the feelings and expectations of individual investors surveyed by the American Association of Individual Investors (AAII) . Bears are people who believe in doomsaying stories (aka the market will go down further). Bulls prefer stories with a happy ending (aka the market will go up). AAII published data goes back de 1987, making it a nice dataset to play with. I did just that as a geeky analyst, and here are my findings.

Investors and advisors are about as bearish as it can get.

According to the AAII bullish ratio 8-week moving average, only 22% of investors are bullish about the future market story. This is well below its "normal" range (within the standard deviation) of 30% and 46%. We see the exact same pattern from the Investors Intelligence Bull/Bear Ratio, another sentiment metric that focuses on professional market advisors rather than individual investors.

Is the Investor Sentiment Index a good investing signal?

Pundits refer to these sentiment metrics as "contrarian" indicators. It's a fancy way to put what is also known as Warren Buffets' most famous quote: "be fearful when others are greedy, and greedy when others are fearful."

As a result of greed, prices typically rise. An overpaying buyer might end up with an asset that provides weak returns. Hence, a good investment opportunity may arise when others are fearful. But is it really? I had to run a few simulations to check this supposed market wisdom.

Simulating returns based on the "fear" index

I assumed fear was high enough when the AAII bullish ratio 8 weeks moving average got below its standard deviation of 30%. For each week this was true, I simulated scenario D where one would buy 100 USD of the SP500 index. The control scenario B was that the same amount invested in scenario A was spread equally every week, independent of the market sentiment. I then compared the total yield of each scenario with 3 different investing time horizons: 5, 10 and 20 years.

Returns Time horizon of each $ invested Scenario D - Be greedy when others are fearful Scenario B - The passive investor 20 103% 91% 10 66% 11% 5 -21% -47%

As you can see, this strategy does look good, beating the control scenario by an average of 3.2x. Not bad at all. The market wisdom seems to be accurate, which means now would be a good time to invest.

What if we combine bear market with the fear index as a buy signal?

I ran a second simulation. This time focusing on bear or "near" bear markets (like the one we are in right now). Scenario A consists of investing 100 USD for each week the bullish ratio is below 27% (I got more conservative), AND we are in a bear market. Control scenario B consists of equally investing each week of a bear market, no matter the sentiment. I also added Scenario C, where one equally invests each week of a bear market independent of the fear index.

Returns Time horizon of each $ invested Scenario A - Buy the panic Scenario B - The passive investor Scenario C - Buy the dip Scenario D - Be greedy when others are fearful 20 221% 91% 212% 134% 10 229% 11% 98% 104% 5 -14% -47% -16% -10%

Scenario A trumps every other scenario. Buying while the fear is high AND a bear market beats the control scenario by an average of 9.1x!

Note how the "passive investor" is doomed to invest for at least 20 years to get a meager return.

Also, note how all scenarios get negative returns if your time window for your money is 5 years or less.

When everybody gets pessimistic about the market, it has usually been a good buying signal for investors with at least an 8 years time horizon. If you need your money in less than 8 years, you are probably better off without investing in the stock market.

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Feeling FOMO already? Read this first

I wanted to understand how much of a rush one should feel when seeing market conditions like the one we live in. So I calculated scenarios where one keeps investing for 3, 6, 12, 18 and 24 months since the beginning of a bear market. Turns out the best average return over the last 4 bear markets is when one invests up to 18 months after entering a bear market, so you better. So FOMO no more.

Is it time to be greedy, or fearful?

We technically escaped a bear market (even though the NASDAQ is deep into it), but the fear index kept increasing. Combining a bear market with high fear has been a good buy signal if history is any guide. The valuation Guru Aswath Damodaran recently valued the S&P500 according to various scenarios. He simulated different levels of risk-free rate (which will depend on how much inflation can be controlled), equity-risk premiums and future Earnings.

There is significant divergence of views on every aspect of value, from where https://t.co/jhPnIWMCRT rates will end up, to whether risk premiums will continue to rise, to how a slowdown may damage earnings, leading to a wide range of values for the index. https://t.co/IctOQRYzih pic.twitter.com/dY1qFWZGcx

— Aswath Damodaran (@AswathDamodaran) May 6, 2022

Giving recession a probability of 40%, like Yardeni's report, to Damodaran's model means the S&P fair value should be around 3.600, with a std. deviation of 800. I know it is pretty broad, but I guess we will see a real bear market sometime this year. I am keeping my short position on the S&P500 and will not open new positions unless mirroring it with a short S&P for the same amount. If we enter a bear market, I will start opening new positions without any hurry. It usually takes 18 months to get the most of a "dollar averaging the dip" strategy from a bear market start.

Disclaimer

The Rookie Investor has a disclosure policy. This article by The Rookie Investor is not financial advice as it does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Have feedback on this article? Concerned about the content? Get in touch with us directly.

To relax on the beach, I personally need tools and services, such as a chair, an umbrella, and either a beer cooler, or someone I can ask for a fresh mojito, Caribean style.

The same goes for relaxed investing. I need tools that cut through the noise and give the bare minimum and timely information to help me make fewer, but better, decisions. I think these tools could help you too. If not, I would be happy to hear from you on how it could be more relevant to you.

Here is a summary of the tools I use and which just got an upgrade.

The Rookie Scorecard

I updated the user experience on the scoring section to simplify its interpretation. I have also integrated the experimental valuation score as directional information, not affecting the Rookie Score.

Currently, there are about 150 stocks that have been scored, part of the process is manual, and part is automated. The automated part is updated every day, while the manual is updated only when there are significant new pieces of information regarding the company business. Today's mean score is 10.5, with a standard deviation of 3.5 points. Everything above 14 is an absolutely rare fantastic business according to the framework. But above 10 is not bad either.

The Rookie alerts

150 stocks updated every day is a lot of info to swallow, which is not very relaxing. This is why I built alerts, or notifications, to deliver only the most significant and relevant pieces of information in a timely manner.

I have been enhancing the design and content of the alerts lately. Here are the ones available today:

• Insiders buying daily

• Insider buying weekly summary (NEW): I realized getting a daily alert of insider buys may be an overkill, so I now have the option to just look at one weekly summary

• Insider buying macro trends, monthly summary (NEW): that insight proved to be very valuable, so I built it into a monthly alert.

• Market outliers (REVAMPED): I got tired of the daily "pull back alerts" as it is too overwhelming when markets are bleeding red, so I replaced it with this instead. It is a bi-weekly alert that summarizes which stocks are the outliers vs the market, both in terms of gains as in terms of losses.

• Stocks to watch: Stock scoring happens every day in the background, so this is a simple weekly update on the stocks that fall into either the "watch out" or the "I like it very much" zone. Manual due diligence is still needed, but it helps spot your next target.

Notification system for your investing journey

These alerts are available through Slack, but could easily be replicated for Discord, Whatsapp, or email. Here is a poll of where you would prefer to set and receive it:

The Rookie Process

The alerts are not meant to be "buy/sell alerts", but instead to help me/you flag the most relevant developments, risks, or opportunities within the watchlist. It helps me focus on where to look to better prepare for my next move.

For example, the alerts can help me detect one of the stocks from my watchlist with fabulous fundamentals (rookie score above 14) has underperformed the markets by more than 20 percentage points. The alert can complement this info with its projected Free Cash Flow compared to its implied growth to quickly view its current valuation. If all the stars seem to align, I will put it on top of the list to make a manual deep dive.

What are the alerts showing right now?

Insiders: March was a busy month for Insiders on the watchlist, one of the most active months since 2021. No less than 32 insiders bought shares from 27 different companies. Most of the buying was happening in the Software industry.

Stocks that look strong: Google (GOOG) looks like the strongest from a checklist point of view, but I won't get into more details because of compliance matters (I work there). Then there is Paypal (PYPL). Paypal hurt me badly recently, but it looks very appealing at its current valuation (scores 1 point on the experimental valuation score) because it still has a powerful moat (scores 13.5 on the Rookie Scorecard). It is crazy to think it is back at the price it had at the bottom of the March 2020 crash (when the pandemic hit). In the same line of thought, I get ASML, DBX and ADSK on the top of the list.

Stocks that look dangerous: these are stocks lagging on the Rookie scorecard and looking expensive on an implicit Free Cash Flow growth basis. The alerts get PLNT, WMT, SBUX, ATVI and INTC on the list, to name a few.

How to access this info and alerts?

You can access the Rookie Score for free on the website database; I revamped how the info is displayed to make it more straightforward. This public database is updated once a month. If you want to have it with daily updates, you need to access it through our Slack channel.

Same for the alerts; you need to join the Slack channel. But I do publish part of the alerts on my Twitter and Instagram feeds for free. 

I did make public the Insider buying macro trend tracking to help find buying clusters by industry over time.

Disclaimer

The Rookie Investor has a disclosure policy. This article by The Rookie Investor is not financial advice as it does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. eToro is a multi-asset platform that offers both investing in stocks and cryptoassets, as well as trading CFD assets. Please note that CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 67% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.

Have feedback on this article? Concerned about the content? Get in touch with us directly.

Since my last newsletter, where I explained how I was hedging part of my portfolio to buy some peace, I have taken a break from market analysis.

I took the opportunity to be away from the headlines to read the latest Warren Buffet's annual letter to Berkshire's shareholders. It is from February 26th, 2 days after Russia invaded Ukraine and well into the stagflation risk drama. The S&P500 was already in correction territory. I was looking at some wisdom in the middle of so much uncertainty. Here is what I found.

How good are Warren Buffet's results?

The letter starts with its results, comparing the 57 years track record of Berkshire Hathaway vs. the S&P500. I was particularly interested in how the oracle of Omaha fared in terms of volatility over the year.

How many years did they lose money?

11 years, or 19% of the time, about the same as the S&P500, which lost 12 years of 57.

What is the Standard Deviation of Buffets' results?

33 pp, vs. 17 for the S&P500 🤯. Boom, Berkshire shareholders had to endure higher volatility than the market. For example, their worst yearly drawdown was-48.7% ☢️, while the S&P500 -37%,

How many years did they underperform in the market?

19 years, that's one-third of the time.

In the end, Warren reports doubling the S&P500 yields over 57 years, with a compounded average of 20% a year (not inflation-adjusted)... This is why he is such a legend, but it is refreshing to see that even a legend can have veeeeery bad years, and not a few of them.

How did he pull this out?

Warren Buffet's core strategy

Charlie and I are not stock-pickers; we are business-pickers. Our goal is to have meaningful investments in businesses with durable economic advantages and a first-class CEO.

How to handle difficult times like right now

We own stocks based on our expectations about their long-term business performance, not because we view them as vehicles for timely market moves. 💣

The backbone of Berkshire's portfolio: Insurance

Berkshire has become the world leader in insurance "float" – money we hold and can invest, but that does not belong to us.

What is insurance float? It is the amounts that insurance companies hold but have not yet paid out to claimants. Thus, this money belongs to the policyholder until the event for which they got insured happens.

Berkshire's total float has grown from $19 million to $147 billion in 55 years. According to Buffet, it is a long-term play by definition and is "immune to precipitous decline".

So far, this float has cost us less than nothing. We have experienced several years when insurance losses combined with operating expenses exceeded premiums. However, we have earned a modest 55-year profit from the underwriting activities that generated our float.

Warren's favorite metric to measure value

The old-fashioned sort of earnings we favor is a figure calculated after interest, taxes, depreciation, amortization and all forms of compensation.

In other terms, he favors NOPAT over the typical EBITDA, or even worse, "adjusted EBITDA". He warns against using any other adjustment to earnings as "deceptive". He partly refers to stock-based compensation when he writes about "after all forms of compensation". That is to say, he considers stock-based compensation (SBC) as a direct cost, just like GAAP accounting standards. So be careful when using the Free Cash Flow definition used in earnings, Bloomberg terminals and so on. It almost always adds back SBC to the NOPAT as a non "cash expense" (but someone will still need to pay for it!).

What is Warren Buffet doing with its investments right now?

Berkshire's balance sheet includes $144 billion of cash and cash equivalents. Of this sum, $120 billion is held in U.S. Treasury bills, all maturing in less than a year.

Meaning: he is holding a significant cash position. Why?

This is the consequence of my failure to find entire companies or small portions thereof (that is, marketable stocks) that meet our long-term holding criteria(...) From time to time, such possibilities are both numerous and blatantly attractive.

He finds the overall market overpriced, can't find good buy opportunities and holds about 20% of its total portfolio in cash. However, he does not even remotely mention that he is selling his positions.

A few days ago, Warren made the headlines. It just announced a deal to acquire the U.S. insurance conglomerate Alleghany for $12Bn. So it seems he did find an attractive enough opportunity in the middle of the current volatility chaos. It's an encouraging sign for the investors freaking out, though it is just about 2 pp of its total portfolio.

What now? I am taking it slow...

Berkshire (...) might be far from the best selection our shareholders could have made. But (...) people who are comfortable with their investments will, on average, achieve better results than those who are motivated by ever-changing headlines, chatter and promises.

This is the last golden nugget from this letter, a lot of humility is needed to be a great investor, but also "comfort" in the strategy you chose in the first place. Consistency + humility, I will chew on that for the rest of the year.

As a reminder to myself, my strategy is to retire by 2030, compounding my savings for the next 8 years. It also means I cannot lose 50% of my investments as Warren did in a single year, else I would not be able to retire by 2030. Or will I? Let's say I invested 100$ in Berkshire right before its worst year ever in 1974 (yes, during the first U.S. stagflation period), and lost -48% right after that. How many years would it have taken me to recover the losses? 2 years... Wow, I was not expecting to be so quick; it would be quicker still if I kept investing regularly. What if I invested right before its second-worst year ever in 2008? It would have taken me between 4 and 5 years if I did not keep investing, and less if I did. That thinking is proper only if the past is a good indication of the future. Still, the past is precisely what bubble historians like Grantham use to warn about the current market conditions.

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Right now is when I can take more significant risks without putting my plans too much at stake, and this is what I intend to do. I did hedge part of my portfolio to buy some peace of mind and to feel more "comfortable", but I will resume stock buying soon. Stay put, stay rookie, stay thirsty and happy investing!

I am not a full-time trader, and investment is supposed to be fun for me. Hence my motto: "Relax, Invest". But I have to say I have all but relaxed in the past few weeks regarding my investments. Why am I worried, and what am I doing about it? Let's first learn from the smartest on the field.

The case for a looming financial disaster, by Jeremy Grantham.

OMG, this folk is depressing. Listening to Grantham puts you in an excruciating position, so why should we listen anyway? Jeremy Grantham is co-founder and chief investment strategist of GMO asset management firm with at least a hundred billion USD under management. He was also involved in creating the world's first index funds in the early 1970s. So plenty of experience in the market. He primarily built his legend by identifying speculative asset bubbles as they unfolded. He correctly identified the Japanese equities and real estate bubble in the late 1980s and the internet bubble in the late 1990s. A decade later, he limited his exposure to the housing bubble before the 2008 crash.

Last year, he started warning of a new bubble in the US equity market. 10 months later, the meltdown started in the so-called "growth stocks", with about 40% of the Nasdaq listed companies shedding 50% or more in market value.

Now, according to Grantham, this is just the beginning. It follows a classic bubble bursting pattern of impacting the most speculative part of the market to then spread to the broader indexes, just like in the Internet bubble. This unraveling can take months to years, but Grantham is positive that it has already started.

His central argument for it is a model his firm built based on the indexes prices, multiples and fundamentals which, according to him, has now reached a 3 sigma deviation. This is a statistical measure of really, really rare statistical deviations, the kind that happens once in a century in statistics, on once every 30 years in the stock market. I wish GMO were more transparent about their model, at least explaining or open-sourcing it, but they aren't, so I can't abide by it.

What makes Grantham extremely bearish is that this equity bubble is supposedly combined with 2 other bubbles, one in treasury bonds prices and one in the US housing market (which increased 20% in the past 12 months, unseen in the history of the US real estate). The latest inflation reading is just more fuel for the fire to begin.

What does Grantham think will happen? The S&P500 will lose about 50%, all the way down to 2500, starting in the next few months, and the bear market could last for years... 😰 This is about as bearish as it can get, scary stuff...

What about "don't try to time the market" or "the best way to time the market is to constantly invest". etc.?

Even though the US market has constantly returned an average of 7% (inflation adjusted) since its creation, it sometimes took longer to recover from massive crashes. Everything depends on your time horizon. The S&P500 took about 7 years to recover from its pre-Internet bubble burst and about 4 years from the pre-2008 crash high. Of course investing on a recurring basis makes these recovery times shorters, but still... The crisis from the late 1920s took even longer, but nothing compares to the Japanese bubble burst, which is just starting to see prices it had back in.... 1991 🤯. So, if bubble bursting there is in the next 12 months, you better not retire in the 5 years, or you are probably f$%$ed. In my case, I pretend to be able to retire 8 years from now, so if this is true I need to cover my ass just in case the worse happens, otherwise bye-bye financial freedom by 2030.

Any optimists amid such doom-saying? Can somebody turn Grantham to ridicule? Please?

Why not start with the person probably most affected by the so-called bubble bursting: Cathie Wood. Cathie Wood is the ARK Investment fund's founder, specializing in "disruptive innovation", the exact kind of company that got slammed in market valuation in the past few months. In fact, the ARKK ETF has lost 55% of its value in the past 12 months. One could argue she has less to lose now. I disagree as her career and reputation are in line big time. Here are her latest readings of the market and economy in general.

Round 1: Housing Market

She first seems to disagree that the housing market is in a bubble, but neither Grantham nor Cathie give a robust analysis either way. So it's a tie.

Round 2: Value vs. Growth valuations

This is the most glaring contradiction between Grantham and Cathie. Grantham says, "take refuge in value stocks, as these have never been so far under the market median", while Cathie says the exact opposite. Granted, "value stock" means whatever you want, as you can see stocks trading for 30 times earnings and still be undervalued on a future cash flow modeling.

Talking about growth and value stock is very misleading. Growth is only one factor driving differences in market-to-book ratios and price-to-earnings ratios. Return on Invested Capital (ROIC) is also critical. McKinsey's valuation gurus found no difference between so-called value and growth stocks in the distribution of growth rates. Nevertheless, they found that growth stocks tend to have high ROIC, while value stocks have lower ROIC. So-called value companies had a median return on capital of 15 percent, compared with growth companies' 35 percent.

Phone a friend: what does the NYU Stern valuation professor, Aswath Damodaran, think of the current market valuation?

Aswath has been teaching valuation at NYU Stern for 35 years (since I was born😵!). He recently wrote about both the current FAANG (FB, AMZN, AAPL, NFLX, GOOG) stock valuation and the S&P500 valuation. In his view, both are not far from their fair value. Aswath is a champion of transparency, so he always shares his models and datasets. I took his model for a spin and customized it to reflect a more conservative view of the economy. I increased the Equity Risk Premium (what investors expect in exchange for greater risk) from 5 to 6%. 6% is in the upper hand of the standard deviation he computes. I also updated the risk-free premium to the actual 10 yrs treasury bond yield to 2%. Finally, I upgraded the risk-free rate from 2.5 to 3% five years from now to put us in the scenario where inflation is here to stay. I kept the analyst earnings forecast and the terminal growth rate unchanged. It gave me that the S&P500 is roughly 30% overvalued with an intrinsic value of 3500. So not as bad as the 2500 Grantham believes, but still bad.

I give a point to Cathie here for transparency as ARK will open-source all of their valuation models. Aswath doesn't seem to see irrational behaviors or extreme bubbles as Grantham does. Still, if inflation keeps surprising us on the wrong side, and the economy flips towards a recession, be ready for a significant bear market that could last years.

Round 3: Inflation and recession

Talking about the recession, Cathie is not very optimistic about the economy either. She mentions the decrease in the workweek, the workers' loss of purchasing power, the bleak outlook Amazon and Meta gave in its earnings, the rise in inventory and the diminishing consumer confidence index. But this is exactly why she does not worry about permanent inflation, as she is forecasting a steep slowdown in consumption. She mentions the recent restart of US oil fracking to explain why oil prices should be kept under control. She does not talk about recession as Grantham, even though highly disruptive companies should not be too exposed to a downturn (for example, the gene-editing tech will grow whatever the economy does). I guess it is why she affirms her price targets for disruptive stocks remain unchanged.

Grantham instead does see inflation as a long-term structural problem. He mentions the worldwide decrease in birth rate as to why the worker base will keep getting smaller, putting pressure on wages and potentially on consumption. For him, ESG imperatives + past commodity price crashes trauma made drillers and miners underinvest their CAPEX for the past 20 years. The commodity capacity shortage has no end in sight (a new mine is a significant undertaking that can take up to 10 yrs before becoming operative). He also mentions climate change as a reason for food shortages to become more frequent. These structurally high commodity prices are yet another reason why inflation would only go up in the medium term and should force the FED to take a stricter stance. A recession shall follow.

Here I see both having solid arguments, but I think Grantham takes a longer view of the forces behind inflation. I give the point to Grantham

Professor Aswath Damodaran summarizes it like this.

"If you believe that last year's surge in inflation is a precursor to a long high and above expectations inflation, you should be shifting your holdings away from financial to tangible assets, and within your equity holdings, towards small-cap stocks, stocks trading at lower pricing multiples (PE, Price to Book) and companies with more pricing power. If, on the other hand, you believe that inflation worries are overdone, and that there will be a reversion back to the low inflation that we have seen in the last decade, staying invested in stocks, and especially in larger-cap and high growth stocks, even if richly priced, makes sense."

Round 4: War

War was not on their radar when they wrote their pieces, and even if its impact on revenues should be muted for European and US stock markets, it will not help with commodity price pressure on inflation. As the West's sanctions on Russia will probably remain for years to come, such pressure won't ease in the short term.

So this is another point for Grantham´s gloomier view

Round 5: Insiders

Neither Cathie nor Grantham talks about Insiders, but this is my personal addition. I will focus on US insiders as it is more transparent with their insider's transactions rules. After seeing a peak of insider buying trx in November and December 2021, principally in the beaten up Software Industry, they have been shyer so far in 2022. It seems their approach is leaning toward a "wait and see" stance. It´s a tie again.

Conclusion

Grantham gets 2 points, while Cathie gets 1. We are in a highly uncertain economic environment, which means high volatility, higher equity risk premium hence lower valuations than a year ago. With that in mind, the US equity market looks like a dangerous place to be invested right now. Some will say times like that are when fortunes are made. Even if you believe Grantham's doomsaying is overdone, it's hard not to worry about one's portfolio in the medium term. What am I personally doing (not investment advice)?

I am highly exposed to US-based high PE stocks. Still, I revisited the valuation of each of my holdings with a very conservative view, both in terms of the equity risk premium and future trading multiples. I have been trimming the ones that look pricey with these new variables over the past months and added to the ones with a decent margin of safety according to my model. Still, if the market crashes, the market won't care much about fundamentals, and all kinds of equity will be affected in the short to medium term.

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So I have been progressively hedging my portfolio by shorting the S&P500 with a non-levered cheap instrument: the SH index (available on eToro). There are also levered short indexes: SQQQ or SPXU to name a few, but these are costlier and not designed to be held for more extended periods. About 15% of my portfolio is a short position, while another 15% is used for defensive instruments such as Cash, Gold and Carbon-offsets. It means I am not "market neutral" but would still feel less pain in case of the bear market is here to stay. In fact, if the market were to pull back another 30%, my short position would grow between 20 and 25% of my total portfolio. It could then be turned into cash to buy astonishing businesses at attractive prices. Suppose the market rebounds instead and grows another 30%. In that case, my short position will shrink to between 5 and 10% of my portfolio, which would "only" grow about 15%. It works both ways; I would "only" lose about 15% of my portfolio the other way around.

Remember investing should be fun? I am buying my peace of mind to "relax and invest" again.

For now, each time I open a new position in a company (I will keep investing), I will mirror it with a short position on the S&P500 to make it market neutral. It means the mix of the two should cancel out market momentums (whether positive or negative) to avoid general market risk and provide uncorrelated returns. Market neutral strategies with this method comes down to companies fundamental exclusively.

That´s it! Stay rookie, stay thirsty, and happy investing! I will keep you posted on how it goes for me from here.