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Equity Analyst utilizing growth framework and process to identify asset-light compounders with sustainable competitive advantages. Need founder-led management who are great capital allocators and invested.
Minimize the left tail: Slugging % > Batting Avg.
AMA: I Am An Investment Analyst at Titan (Wed, 11/10 @ 7PM EST)
I am excited to participate in Commonstock's recurring 'ask me anything' segment.
On Wednesday November 10th, at 7 PM Eastern Time, I will be hopping on to answer your questions live for ~1hour.
But please feel free to enter questions ahead of time in the comments section, and I will get to them.
Some Background on Me:
Most of you will know me as @2chasegreatness on Twitter. I joined FinTwit in 2020, growing an audience of ~35k, and started a Substack (which I have had to discontinue) late last year. In March I organized the first ever FinTwit Summit along with Dhaval Kotecha. Prior to that I have been an Investment Banking Analyst, a Manager of Corporate Finance, and an Investment Analyst at a family office. In my previous roles I did a lot of due diligence, financial modeling, valuations, financing and other transaction support functions throughout the deal life cycle for investment opportunities. My private market experience in portfolio management and investment analysis includes capital raising, forecasting, return analysis, cash flow forecasting, and debt / capitalization management and analysis.
I aim to develop alpha-generating ideas through detailed bottom-up, fundamental analysis, coupled with a macroeconomic, top-down view, and technical analysis. My goal is to ultimately find stocks that are mispriced in the market and have a high probability of appreciating towards my personal view. While I lean towards the classically labeled “growth” stocks, I believe this is a distinction without a difference. I am a generalist but am more familiar with tech, specifically the software, internet, and semiconductor spaces.
I have developed a rigorous investment process and framework for public market investing, which I am constantly refining.
In June 2021 I joined Titan as an Investment Analyst.
Check back in this Wednesday 11/10 where I'll be answering your questions in the comments at 7 PM EST.
See you then!
FYI if you are following $KLIC - pre-announced earnings beat and guide to top of the prior range. My belief here is that the guide for this Q is not the story. Expecting the real news will come during earnings when the company guides to a much higher 2022. Stay tuned.
A reminder as we head into earnings season. It does not matter how much a company grows or expands margins YoY or QoQ. What matters is how the company performs & guides relative to consensus.
Stocks are priced based on the PV of its expected future CFs, not past CFs. Key word being “expected”. When those expectations change, the stock price follows LT.
However, immediate price action is not directly positively correlated to beating or missing consensus. Directional LT bets are easier to make.
A lot of us have exposure to software/high-growth tech names that re-rated higher following the March 2020 crash and subsequent liquidity injection into financial markets. Most people relate this rise to lower interest rates, which benefit longer-duration assets. Let's frame this conversation under this context.
To be abundantly clear - I have no idea if rates will continue to rise, how fast they will rise, or what the impact will be on multiples/valuation. However, we can use a simple framework to understand the relative risk of these assets at current prices.
Let's start with relative valuations at today's prices. The chart here illustrates how high-growth SaaS (including DevOps and Data & Analytics companies) are trading relative to estimated forward sales. Think about this as growth-adjusted EV/S or PEG in EV/S form. Some of the best opportunities I see today like $ESTC $TWLO and $OKTA show up here.
Taking one step back, let's see how a lot of these names have performed in past drawdowns. Specifically, what were the max drawdowns and associated recoveries during each cycle for many of these names? The included chart is a helpful visual to juxtapose these drawdowns to moves in the 10Y. H/T Wolfe Research
Two quick takeaways:
- I can't help but notice the higher correlation between the 10Y and IGV in the more recent period compared to pre-2019. I haven't run real calculations but the visual is directionally helpful.
- If we are in another drawdown, we still have significant room to go. Coming into this week, the average drawdown was ~7% compared to 20% in prior cycles.
If the Fed cannot successfully disintermediate tapering from interest rate moves, we could still have some rocky months ahead as the market continues to handicap interest rate moves. But this is not a macro take - I want to now crosswalk to max potential drawdowns if we move to a multiple regime in-line with pre-COVID levels.
Below is an analysis comparing the current EV/S multiple against pre-COVID, post-COVID and historical (beginning 1/1/18) multiples - average, median, max, min. Additionally, the up/down skews are seen to the right. Negative percentages are downside, positive are upside from here.
- If multiples rerate to pre-COVID levels, most stocks could see severe declines and compression.
- Most of these names are well-positioned if multiples stay consistent with post-COVID levels.
So what? What do we do then? Well, I for one wouldn't be holding only SaaS / high-growth names. Plenty of companies offer attractive forward returns without the exorbitant drawdown risk. However, I would also try to understand how the highest quality names could perform through cycle / how fast these names could "grow into their multiples".
While I don't have all the answers, I wanted to assist your analytical efforts by providing the information.
How do you all think about SaaS exposure here given current market dynamics?
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Sitting on the tarmac waiting to take off and been a while since I’ve posted here, so wanted to see how the CS community thinks about their portfolios in this context.
How many positions do you hold & why?
Is your largest position on cost your highest conviction idea?
How do you define/measure a great company? What’s your proof?
How many great companies do you think are out there?
Do you own any companies you don’t consider great? Why?
Looking forward to hearing from you all.
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- Probably around 7-10 give or take, don’t know exact #. I like making highly concentrated bets, if I believe in a company I should be confident enough to throw a large chunk of cash behind it
- Largest position is $ETH.X and it is by far my highest conviction play right now. In terms of stocks $PTON is my largest. I think they have the best product and team on the market.
- I think a great company has an outstanding product, great team, and happy customers. I have a very fundamental view
- I’d say 30% of the market. Hard question though. I went with my gut
- I own a company that I don’t know if it’s great YET. $EGLX. Still need to read more into it, but initial research was good enough to pick up a few shares
It's been a while since I posted a memo on here, so if you don't mind, I'm going to riff on Kulicke and Soffa($KLIC or "K&S"), a company which I have been aggressively bullish on since diving into a research process a month ago. Some of this I posted in the Semiconductor chat. I will follow this up with a broader semi industry update tomorrow. It's nearly past my bedtime right now.
So, I couldn't care less about a move from a day or a week. The real value will come when the Company re-rates as the market realizes this Company is 1) a secular in cyclical right tail investment with 2) lower future volatility. Both drive a higher multiple for the stock - look at front-end WFE, all trade at a premium to KLIC. Which, based on history, makes sense - it should. The front-end equipment market was historically plagued by similar exacerbated oscillations that the back-end has continued to experience; these equipment cycles are levered (high beta) to chip shipments. However, around the beginning of the last decade, a variety of necessary advancements in production technologies drove value to the front-end; the follow-on effect being more stable cycles as a result of faster equipment upgrade cycles and the ever-growing share of maintenance & service business on the equipment (more on this later). Value in the equipment market, even with advanced packaging, has mostly accrued to the front-end. But as I mentioned in my write-up, that is changing now.
It is this inflection point that is driving a fundamental change in Kulicke and Soffa's business model and is grounds for the oncoming rerating. Packaging equipment is now a necessary part of the front-end along with most other parts of the chip production process. This is a necessary requirement as packaging is now being used to improve PPAC (power, performance, area, cost) through tighter integrations and connectivity. Especially as we move towards a heterogeneous packaging paradigm, combining all different types of processors and components onto a single substrate (or even chip), the packaging needs to be contemplated on the front-end. This will not happen immediately, as design capabilities continue to develop to incorporate packaging, and customers build out these capabilities. This will drive more stability in the Company's order flow and faster upgrade cycles, just like the front-end has experienced. $AMAT $KLAC $LRCX and Tokyo Electron all trade at NTM EBITDA multiples around 17-18x; $KLIC trades at 9.7x (on light consensus). I'm leaving out $ASML from these multiple discussions because it trades at a rightful premium to all (more than happy to elaborate on this). K&S is trading at a 35% discount to its peers larger peers. $FORM is trading at 30.5x NTM P/E and BE Semiconductor, a leader in flip-chip packaging, is trading at 23.5x. There is no other way for me to say this except KLIC IS GOING TO RERATE HIGHER. Assuming just 20x on my 2022 earnings estimate of $5.50, $KLIC should be trading at $110... just quick BOE analysis that triangulates nicely with my EPV analysis of $105.
Furthermore, I just got an update from IR on all things, they just had a big TCB design win for a 7nm crypto mining use case - which beat out flip-chip. This is important to understand given the industry dynamics. When flip-chip came around in the early 2000s, it was supposed to supplant wire bond (which KLIC is the undisputed industry leader). Fast forward 20 years, wire bonding is still the packaging methodology for 80% of all ICs. So now with TCB, which will be the logical method for SiC and other advanced packaging techniques, KLIC has the durability of wire bond and upside from TCB (they also have flip-chip but BESI is the leader in the room).
Ok, all of this being said, I don't even contemplate the massive growth driver percolating in the company... miniLED. The Company's miniLED line is a result of its acquisition of Assembleon back in 2015 (for 1.1x revenue, no less). Without going into the details, miniLED is the next-gen OLED and enables the resurgence of LCD. Apple just announced miniLED screen for the iPad right? I'm still trying to confirm, but am pretty sure KLIC won the design for the packaging equipment for the miniLED screens used for the iPad. This is MASSIVE. Because then they will be the logical choice for when this transitions over to the MacBook and given the experience, I'd give it a high probability they win the Android business next year. This is ALL upside for me though, with just the base case display and core packaging business, the stock should be at $70 right now.
Last quick comment. MiniLED represents a $2.5B revenue opportunity for a company currently doing $1B in revenue run rate. And at higher margins. I could go on... additionally, big note on the updated earnings guidance is that K&S' supply chain has eased - so they are able to meet capacity demands, while everything remains tight ahead of them for their customers. What a beautiful setup.
SINGAPORE, April 19, 2021 /PRNewswire/ -- Kulicke and Soffa Industries, Inc. (NASDAQ:KLIC) ("Kulicke & Soffa", "K&S" or the "Company"), today announced that it expects revenue to be approximately $340 million and non-GAAP earnings per share to be approximately $1.20 for the second fiscal quarter, ended April 3, 2021.
Strong demand for K&S solutions continued to stem from the general semiconductor, automotive and LED end-markets throughout the second fiscal quarter. In addition, the Company has continued to drive adoption of its leading-edge semiconductor offerings supporting high-density assembly, and also its advanced LED solutions supporting emerging mini-LED capable displays.
Fusen Chen, President and Chief Executive Officer, stated, "We remain very focused in supporting our customers' capacity expansion plans while also delivering new solutions that address fundamental challenges within the growing assembly market. Separately, we have also made significant progress to mitigate near-term supply chain constraints, which improves our outlook into the fiscal second half."
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FinTwit Summit - Hype!
$CRWD reports its FY Q4 2021 tomorrow. Consensus estimates are pegged at 64.8% YoY (7.8% QoQ) Revenue growth, for $250.7MM.
CRWD has averaged a 7.1% beat the past 5 quarters.
I'm forecasting $269MM top-line; 77% YoY / 15.8% sequentially.
$125MM net new ARR; 25% customers adopting +6 modules.
What do you have?
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Expectations Investing - Calculating Market Expectations
Michael Mauboussin is one of the thought leaders that has most influenced my investing framework. His "Expectations Investing" was a seminal work in my development. He wrote a paper nearly a decade ago about understanding PE multiples, from which I gained a deep understanding of the analysis below. I will elaborate more on this in a future newsletter.
A critical component of my process, adopted from Mauboussin, is truly understanding market multiples and breaking them down into their component parts. Through this, I am able to understand the two components of a company's value: 1) steady-state value and 2) future growth value. This is important so that you can determine how much you are paying for future growth and more importantly if you have a materially different view from the market.
Why is expectations investing the optimal method for valuation IMO? Because instead of trying to make assumptions to arrive at an estimate of value, you are really reverse-engineering the process/company value. Simply, since we know the price (thus, value) of a stock, we only need to ask ourselves "what needs to happen for this price to make sense."
This process illuminates what I believe are the most important factors of company value - discussed further below:
- Return on Incremental Invested Capital (ROIIC) is the most important component of understanding value creation. If ROIIC equals the cost of capital, then investments don't create any value.
- Illustrates the impact of growth/investments, which can be seen via the spread between ROIIC and cost of capital. So, if there is a wide spread in these figures, more rapid growth adds more value.
- Thus, investors should focus on growth LAST. Rather, the importance lies in the company's ability to generate ROIIC > Cost of Capital, sustain this spread over time, and create future investment opportunities. The time during which ROIIC is greater than cost of capital is the period of a company's sustainable competitive advantage.
Alright, so let's start with thinking about firm value as I discussed above - steady-state vs. future growth values.
We have to make a really important assumption, that the current steady-state value can be sustained indefinitely and future investments don't add or subtract value (this is captured in the growth value). Based on a steady performed from 1961-2013, the steady-state accounted for ~67% of total company value on average. Before providing the calculation, I recommend understanding the implied steady-state P/E multiple or cost of capital. If you have a calculated cost of capital, the P/E = 1 / Cost of Capital. You can calculate cost of capital using the same formula with a known P/E.
Stead-State Value = Normalized NOPAT / Cost of Capital + Excess Cash
Normalized NOPAT utilizes a sustainable tax rate (I will look at mature comps or assume a 26-30% effective rate). For those of you unaware, NOPAT is "Net Operating Profit After Taxes" which is the operating profit assuming no leverage. It is calculated simply as EBIT * (1 - Tax Rate).
Future Value Creation
There are three main drivers to future value creation:
- Spread between ROIIC and cost of capital
- Magnitude of investment
- How long a company can find investment opportunities at this positive spread
*The first two points dictate the company's growth rate
The one difficult aspect to assume is #3, duration of competitive advantage periods. What I do is combine the company's narrative and competitive positioning with base rates. Historical calculations show the market implies roughly 6 years or more of this period. Brett Olson estimated the average from 1976 - 2007 was about 8 years, with a minimum of 5 years in competitive industries and 15 in stable industries.
Step 1: Calculate ROIIC = (NOPAT @ t1 - NOPAT @ t0)/Investment @ t0
- NOPAT is calculated the same as above
- Investment = Net Working Capital + Net Capital Expenditures (net of Depreciation) + Acquisitions
- This formula makes a VERY important assumption that all NOPAT growth is from the previous period's investments, which we know isn't necessarily true.
Step 2: Calculate Future Value Creation = [Investment (return on capital - cost of capital) competitive advantage period] / [Cost of Capital (1+Cost of Capital)]
So, what I do is calculate the company's values for each state of value. Then I can subtract the steady-state value from the company's current enterprise value to calculate what the market is pricing in for future value creation. Comparing the implied value in the market to the future value I calculated can give insights into if the market is under or overestimating firm value. This is the first step to generating alpha. I pasted an image of my simple analysis below, more than happy to provide more info:
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I'll admit a lot of this is over my head. Going to dive into that paper you linked. Valuation is something I need to work on still. This type of analysis reminds me of option pricing and estimating implied volatility vs the market's expectations of the of vol and trying to find edge (alpha) so intuitively this makes sense to me, need to dig deeper though.
Investing in Different Markets - An Introduction to the CAN SLIM Methodology
I published my latest newsletter today that provided a summary of the CAN SLIM methodology, how to determine the type of market environment we're in, and how to invest in each. This empirical methodology was developed by the legendary Bill O'Neil based on market behavior dating back to the 1880s.
I personally know PMs at the O'Neil family office and saw firsthand how they avoided the majority of the March 2020 drawdown and got back in near the lows. It has proven effective to avoid similar major corrections like the dot-com bubble, GFC (example in the newsletter), and 2018 taper-tantrum.
While I won't copy and paste the entire article, here are some of the highlights:
How to Determine Market Direction
Since we are already in a correction, I will start with how to determine with a high probability that the market is going into a correction.
Distribution Days: Distribution days occur when Nasdaq or S&P 500 are down more than 0.20% (this figure varies slightly) on higher volume than the prior day. These days are significant because they are a sign of institutional selling. While institutional buying is known as accumulation, institutional selling is known as distribution. The question is then how to use distribution days to determine market direction? There are three components of this trend analysis: 1) the number of distribution days, 2) the cadence/speed/frequency of distribution days, 3) the intensity of distribution days. What this means is that a build-up of distribution days on an index in a short amount of time often indicates a change from an uptrend to correction. To be specific, usually, 5 - 7 distribution days within a 4 - 5 week (20-25 trading day) period will mark this change in trend.
While the accumulation of distribution days indicates when a market changes direction from an uptrend to a correction, follow-through days indicate a change in market direction to the upside.
Follow-Through Day (FTD): A FTD indicates a market correction has ended and a new uptrend has possibly begun. The follow-through day occurs after the major indexes have been trying to rally higher from a recent bottom. A follow-through is an up day in the market of at least 1.25% (this figure varies slightly) on rising volume which usually occurs on the 4th to 7th day of an attempted rally. Note - the FTD must occur on the fourth day after a market bottom or later. If the market undercuts a prior low, the day count resets. A FTD confirms the rally is working and the market trend is changing back to the upside. A follow-through day is an indication for investors that it is time to slowly start increasing exposure by buying strong fundamental stocks that are breaking out of constructive bases.
It is important to understand that a follow-through day has to occur at least four days after a market low during a market in a correction. I keep speaking about probabilities, so the question you should be asking is, "what is the probability that a follow-through day represents a change in the market's direction back to an uptrend?" It turns out that ~70-75% of follow-through days are successful - meaning they indicate the market is resuming an uptrend. This is why I said investors should slowly start buying stocks and getting back into the market, in case the FTD fails and the market reverts into a correction.
- Have a Process: I discussed my process in this article. I'm not saying it is the right way or the only way to manage a portfolio. It is the best way I know how to manage risk and capture upside through active management. You can agree or disagree with all or parts of my process. But what matters is that you have a process, not that you adopt mine specifically.
- Active vs. Passive: The process described herein refers to how I approach my actively managed portfolio. My retirement account consists solely of ETFs and I DCA.
- Probabilities and Objectivity: My portfolio management decisions are solely based on empirical probabilities. I follow a rules-based approach to remove emotions from my decision-making process, letting objectivity drive my actions.
- Learning Process: I am constantly learning what works best for me and my personality. I update my process and rules when I get new information, either by making mistakes or experiencing success. I am still new to managing a portfolio and by no means have it all figured out. I will always be learning and refining my abilities, thank you for coming along for the ride.
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Hands down the best technical process breakdown I’ve read in a long time.
I wish I was this disciplined and could outline my process like this... Seifel is giving out gems on this one. 🔥