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Pandemic Paradox - Quality on Sale


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As hot money chases reopening plays, many high quality stocks are selling off  -- non-cyclical companies that are consistently growing EPS 10%+ per year. I'm not talking about COVID high-flyers like Zoom or Peloton. By reasonable valuations, I mean less than 30x earnings.

 

The paradox is that many of these companies grew during the pandemic but their stock price (or at least valuation) decreased. Some are in 20%+ drawdowns. And many of the reopening plays are already selling at higher prices (and much higher valuations) than prior to the pandemic.

 

This seems like a pretty classic "voting machine versus weighing machine" time arbitrage opportunity.

 

Here is one example from my portfolio comparing a Covid winner vs Covid loser. Pre-Covid (Feb 20, 2020 ) to post-Covid:

 

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Stock, Total return, 2020 EPS, fwd PE

DPZ: -10%, +29%, 25x

Ulta: +8%, -72%, 36.6x

 

A few random GARP/defensive stocks:

 

Stock, P/E fwd*

OTEX, 13.35

MRU.to, 15

ORLY, 17.36

DG, 17.92

FB, 20

ATD.B.ca, 20

DPZ, 23

 

* FWD P/E from Yahoo finance based on 2022 estimates.

 

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TLDR: A good time to shop for high quality stocks especially given prices on other assets.

 

 

 

 

 

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I don't believe that forward P/Es exist.

 

FB is trading at a 26 PE, which I believe is reasonable if not speculative given how hard Apple is going to karate chop the core of their business model, and how poorly Facebook is dealing with that, like it does all external issues.

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I'm always eager to own good companies I can hold for long term and upgrade from some of my more asset heavy stuff. I've mostly been struggling to get there when I pro-forma for higher tax rates and covid tailwinds becoming headwinds. Probably being too valuation sensitive and have been considering legging into HD, DG, COST, DPZ, etc.

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I don't believe that forward P/Es exist.

 

A once-in-a-century pandemic might distort 2020 numbers? Ulta is selling at 83x. BKNG at 70x. DIS at 44x. The Pandemic Paradox companies are clearly bargains on LTM earnings.

 

My argument is that they are also relative bargains after reopening. In many cases, they are absolute bargains after reopening.

 

 

 

Using trailing numbers makes FB look even cheaper:

https://app.koyfin.com/share/a76ce09d71

 

But this isn't about FB. It is about a basket of stocks that grew earnings last year and are in double digit drawdowns.

 

 

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I don't believe that forward P/Es exist.

 

A once-in-a-century pandemic might distort 2020 numbers? Ulta is selling at 83x. BKNG at 70x. DIS at 44x. The Pandemic Paradox companies are clearly bargains on LTM earnings.

 

My argument is that they are also relative bargains after reopening. In many cases, they are absolute bargains after reopening.

 

 

 

Using trailing numbers makes FB look even cheaper:

https://app.koyfin.com/share/a76ce09d71

 

But this isn't about FB. It is about a basket of stocks that grew earnings last year and are in double digit drawdowns.

 

Koyfin's trailing numbers are the exact same that I quoted. If they aren't, Koyfin is wrong since I took mine directly from their SEC filing.

 

I would never trust 2022 estimates from Yahoo or anyone else. Do you own homework and read their reports and come up with a trustworthy estimate of their future earnings. While remembering COVID effects aren't over, and won't be over this year, if ever. Post pandemic, people are going to work remotely, shop from home, and watch new movies at home much more than before the Pandemic. Westerners are going to wear masks more often and every new disease scare will be much more likely to provoke short term lockdowns. So think about how likely hangover effects will impact each individual business.

 

My Facebook example is you really need to comfortably model the effects of restrictions on user tracking that are likely to be put in place by Apple on iOS and in Safari, and by other browser makers in the next few years. So it doesn't matter what FB was trading for in 2019, or in 2020. It only matters what it's worth in that new environment. Maybe they'll be able to minimize the effects, and its a buy. Maybe its a disaster, and that 20 forward PE is actually a 50 forward PE.

 

And lastly it doesn't matter what any stock traded for before the Pandemic, or during the Pandemic. You can't decipher the whims of the market mob. What matters is their intrinsic value and catalysts for unlocking that value. That can only be found by reading their financial reports.

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You can't decipher the whims of the market mob. What matters is their intrinsic value and catalysts for unlocking that value. That can only be found by reading their financial reports.

 

I'm not trying to front run the mob. If they are stupid enough to sell me exceptional companies at cheap prices, I buy them. I'm simply observing that the market is selling boring, quality companies to pay for reopening plays. In many cases, the valuations are starting to get attractive.

 

P.s. I'm not using FWD earnings to show what I THINK the companies will be earning in 2022. This is a rough estimate of what the street thinks. Obviously, I am looking for bets where I am confident they are wrong -- usually when the market is overly concerned about some minor or temporary concern (IDFA).

 

That can only be found by reading their financial reports.

 

It is tempting to believe this but it does not match my experience or investing style. Here is one painful example. In 2014, investors dumped Amazon after it wrote off $170M for the kindle phone. The stock went below $300. I knew it was cheap. I knew it had excellent management. I knew it would be a dominant company. I was an AWS customer, so I knew the potential. But I spent months going over the numbers and I could never get an accurate estimate for IV. The range of potential outcomes was always absurdly large. I didn't buy AMZN at $300 because I read the bloody financial reports and tried to come up with a trustworthy estimate of their future earnings.

 

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I would add progressive to the list. This looks seriously cheap at this point.

 

It does. Thanks for pointing it out.

 

Maybe I should think less and buy good companies like PGR, but the overanalytical bear in me says at some point people start pricing in a secular decline in premiums due to autonomous driving making driving much safer, and I don't want to own this when that happens. Maybe that's too far off to care about now.

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I would add progressive to the list. This looks seriously cheap at this point.

 

It does. Thanks for pointing it out.

 

Maybe I should think less and buy good companies like PGR, but the overanalytical bear in me says at some point people start pricing in a secular decline in premiums due to autonomous driving making driving much safer, and I don't want to own this when that happens. Maybe that's too far off to care about now.

 

If you normalize margins for typical (non-COVID) driving/accident volume (11.5% EBIT margin on premium written was my two-minute back of the envelope) and assume zero investment gains (probably have unrealized losses YTD give rising rates), is Progressive trading at 14x 2020 "normalized" earnings?

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I don't have the exact numbers on me but 14-16x normalized seems about right. That's insanely cheap for a company that consistently posts double digit growth rates. Especially in the context of the multiples we are seeing today. I keep thinking that I must be missing something, but I don't think I am. PGR also posted double digit growth in the number of policies in 2020 which is absolutely amazing as 2020 was not a year that people go shopping for car insurance.

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I agree on your point and actually sold Ulta last week. Quality biz but valuation is starting to look very demanding.

 

With the risk of sounding like a shameless tobacco salesman, MO and BTI are very cheap and inflation and recession resistent.

 

Fiserv also interesting, 75b mcap, 30b FCF towards 2025 per management - a large part of which will be towards buybacks. DD eps growth. Massive buybacks, undemanding valuation and high ROIC organic growth can be very powerful.

 

Ebay also looks interesting actually, but it is more difficult for me to figure out their growth going fwd. If it gets slammed in a broad tech selloff, might be worth to try and dig deeper. It's a cashflow monster.

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I don't have the exact numbers on me but 14-16x normalized seems about right. That's insanely cheap for a company that consistently posts double digit growth rates. Especially in the context of the multiples we are seeing today. I keep thinking that I must be missing something, but I don't think I am. PGR also posted double digit growth in the number of policies in 2020 which is absolutely amazing as 2020 was not a year that people go shopping for car insurance.

 

Why not? If you sit at home and don’t drive much, why not shop for a cheaper insurance?

 

I generally agree on PGR being fairly reasonably priced, but I do think that the advent of self driving cars will keep a lid on the exit multiple. At some point, they have to pivot into other kind of insurance and it is unclear if they have much of an advantage in anything but car insurance, plus the tails are longer, which drives different economics.

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Because people shop for car insurance when rates go up. 2020 was not such a year. People stayed at home, rates went down, rebates were received etc.

 

I'm not too worried about the self driving aspect I think it's still a ways off and it's not gonna replace insurance. It's gonna affect accident frequency and severity maybe that will be somewhat offset by the fat that the cars will be more expensive. So the risk is that premium per policy will decline somewhat. But PGR is really, really good at taking share which I think it'll continue to do despite already being #3. So I'm more bullish from a policy growth perspective rather than a premium per policy perspective.

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I agree on your point and actually sold Ulta last week. Quality biz but valuation is starting to look very demanding.

 

With the risk of sounding like a shameless tobacco salesman, MO and BTI are very cheap and inflation and recession resistent.

 

Fiserv also interesting, 75b mcap, 30b FCF towards 2025 per management - a large part of which will be towards buybacks. DD eps growth. Massive buybacks, undemanding valuation and high ROIC organic growth can be very powerful.

 

Ebay also looks interesting actually, but it is more difficult for me to figure out their growth going fwd. If it gets slammed in a broad tech selloff, might be worth to try and dig deeper. It's a cashflow monster.

 

They switched to managed payments and will be taking PayPals cut now.

 

Haven’t looked at reports so don’t know if they’ve been doing well since courting volume sellers & starting to push BIN listings.

 

They’ve proven their stickiness over the years by pissing me off multiple times and yet, where else can I & other casual sellers go to sell our garage sale junk for significantly more money?

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FWIW, just bought some more COST shares yesterday AH after they missed earnings.

 

Anecdotally, I also just ordered a washer dryer set from them to stop endless complaints from my wife about the washer 'eating' her laundry. COST e-commerce is a massive opportunity and they have not been good at it traditionally (the website is still so so), but they are getting much better. I love them for big ticket items because of their better return policies.

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Fiserv also interesting, 75b mcap, 30b FCF towards 2025 per management - a large part of which will be towards buybacks. DD eps growth. Massive buybacks, undemanding valuation and high ROIC organic growth can be very powerful.

 

This looks really good. It is on my watchlist for some reason even though I've never done any work on it. Will take a look today.

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Fiserv also interesting, 75b mcap, 30b FCF towards 2025 per management - a large part of which will be towards buybacks. DD eps growth. Massive buybacks, undemanding valuation and high ROIC organic growth can be very powerful.

 

This looks really good. It is on my watchlist for some reason even though I've never done any work on it. Will take a look today.

BlueToothDDS on Twitter has a good summary, gets you up to speed in 5 min. It is from december, when Fiserv had an investor day.

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Fiserv also interesting, 75b mcap, 30b FCF towards 2025 per management - a large part of which will be towards buybacks. DD eps growth. Massive buybacks, undemanding valuation and high ROIC organic growth can be very powerful.

 

I owned Fiserv from mid-2010 until January 2020, and that reliable high-ROIC growth was what I liked about the business. The reason I sold it was that organic top line growth seemed like it was approaching GDP growth levels. It seemed to me as though the merger with First Data was two wide-moat but low-growth companies trying to distract from the fact that neither business had a plausible growth strategy.

 

Am I wrong in that assessment? Do you have a theory about why Fiserv will have solid organic top line growth for the next few years (or the next decade, ideally)?

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CL is another one that looks quite cheap on a P / Normalised FCF basis. Has struggled for the last 5 or so years, but has new management, a credible turn around plan based on increased brand investment, and reaccelerating organic growth.

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