Taking all of the principles we’ve discussed thus far in mind, here are 20 great companies that meet our criteria. We consider all of them to be great options to buy and hold for the next 20 years. You will have heard of some of these names, while others might be unfamiliar to you. Due to the nature of analyst reports, you will also read mixed reviews of every single company mentioned here. Keep in mind the principles discussed in the previous two modules when reading about these companies.
Market cap – $188.67 billion
52 week high/low – 153.41/79.07
Disney is one of the companies most affected by the COVID-19 crisis. Its parks have been shut, and direct to consumer sales have dropped significantly. In fact, Disneyland has even been dubbed ‘the emptiest place on earth’ thanks to the shutdown after the virus pandemic.
There’s no denying that Disney faces rough weather over the next 12-18 months. This is primarily because the effects of the virus will spread far and wide. It is gradually becoming clear that the longer it takes to find a cure for it, the worse the economic outlook.
As of this writing, Disney stock has plummeted t0 around $101 from highs of $140 in February. That’s a drop of over 25% in less than two months. Market sentiment is bearish. So, why do we think Disney is a great stock to own for the next 20 years?
While the short term future for Disney’s parks and direct to consumer retail businesses is pretty bad, there’s no denying that the brand and its intellectual property has a highly sustainable moat. Put it this way: If your child was given a choice of visiting either Disneyland or going to Pete’s Fun Park, which one do you think they’d be likely to choose?
Disney has been associated with fun and cartoons for such a long time now that it automatically invokes feelings of childhood when a person hears about it. Despite this strong moat, the company has continuously worked to make the experience at its parks even more enjoyable.
The launch of the PlayDisney Park app turns even longer wait times in lines into a fun experience. This indicates the innovative nature in which the management of the company attacks its weak points. People don’t like waiting in long lines. While the PlayDisney Park app may not remove this weakness entirely, it does go a long way towards reducing its negative effects.
Another critical development to watch out for is this: The company has purchased 26 acres of land in Orlando that lie adjacent to the Magic Kingdom, which is one of the oldest Disney parks in the world (Saibil, 2020). This is not the only purchase the company has made. In fact, it happens to be the smallest purchase. Overall, the company has bought close to 5,000 acres of land in an attempt to improve the experience at its parks and resorts. Reinvestment of such scale indicates that management is quite confident of the cash position of the company and are looking to extend their competitive advantage.
Disney is a lot more than just its parks, even if this is the first association people make. The company is a media conglomerate with its hands in almost everything you can think of. We’ll get to the extent to which Disney dominates the media world shortly. For now, the most significant development has been the launch of Disney+, the company’s streaming service.
Disney has been seemingly late to the streaming game and on the surface of it, competing against the likes of Netflix and Amazon Prime Video seems like a tough job. However, the company has successfully avoided trying to be a pioneer. Instead choosing to wait for its rivals to work out any kinks in the process.
The success of Disney+ shortly after its launch proves that the strategy has paid off. As of this writing, Disney+ has over 28 million subscribers in the United States alone. In comparison, Netflix has 60 million subscribers despite having been around for more than a decade now.
Given that Disney+ has just launched, this number is only going to grow in size. It isn’t just the domestic market that the company has managed to penetrate. With sensible acquisitions of streaming services in emerging markets, the company has managed to gain an outsized footprint in these markets.
A good example of this was the purchase of the Indian streaming app Hotstar. India has one of the highest penetration and usage rates of mobile data in the world. It also happens to have some of the cheapest data plans in the world, and the price is the primary evaluation tool before signing up for any service.
Netflix and Amazon found this out pretty early, and both companies have not made any significant headway in this regard. Netflix currently has just 2 million subscribers in India (Gupta, 2020). In contrast, Disney+, launched via Hotstar, had over 8 million subscribers on day one.
A significant chunk of Disney’s business comes from the licensing rights it owns for a number of movie franchises and other content. All those Marvel movies that occupied our imagination for over a decade? Disney owned all of them. The Star Wars franchise? Owned by Disney. The company is more than just Mickey Mouse.
The extent of Disney’s domination of the entertainment industry is highlighted by the fact that the company owns even smaller animated studios. Pixar is a name that is associated with high-quality animated films and Disney owns the studio outright.
In short, almost all content that is distributed to children is owned by Disney, and this creates a steady and gargantuan revenue stream in form of royalty payments. Imagine writing a book that continues to sell for 100 years, and you simply get to pocket the royalties forever. Now, multiply that by a few billion. That’s what Disney is sitting on. That’s without taking into account the lifetime customer value of these children as they grow into adulthood and have children of their own. Such is the power of an intangible asset such as nostalgia.
Disney’s most robust quality over time has been the pragmatic nature of its acquisitions. The company has never been shy about acquiring competing businesses and then allow those businesses to have a free hand while under the Disney umbrella. Pixar is a great example of this.
Pixar was originally an upstart competitor that disrupted the traditional Disney animated movie formula. While Disney’s movies were epics loaded with songs and all sorts of heavy-handed dialogue (think The Lion King), Pixar’s movies were light and still managed to pack a punch to the gut of every adult who watched them.
Conventional wisdom would have dictated that Disney use its significant resources to crush the upstart. However, Disney made the pragmatic choice of simply buying Pixar out and giving it full freedom to whatever it wanted, even if it competed against Disney’s non-Pixar animated movies.
A similar example was Disney’s acquisition of television networks ABC and ESPN. A first, it seemed that Disney was playing far outside of its field of competence. However, the strategy is quite clear now. Despite there being no link between cartoons and sports, Disney now occupies significant market share in the media sphere, and this almost guarantees the success of its ventures in the entertainment field.
As such, the company is a snowball rolling downhill when it comes to the media and entertainment business. It sustains itself and will continue to do so in the future. This is because its subsidiaries have substantial moats of their own to support themselves.
These are extraordinary times as you can imagine, and there are significant challenges for Disney to face. The first is the significant loss of income from the park and merchandising business. In 2019, as per Disney’s annual report, the company earned over $6.7 billion from these avenues.
In addition to this, it also earned over $2.6 billion from studio revenues. Both of these income streams will be massively affected, thanks to the shutdown. The company does have $12 billion in cash reserves. This ought to be enough to tide the company over any short term crisis, however, replacing close to $9 billion in earnings is going to be pretty tough.
However, Disney is hardly the only company facing such a crisis. Pretty much every single business in the world has to weather the storm. Disney has the luxury of leaning on its media network businesses, which ought to see a rise in earnings as time goes on. As of 2019, this division earned $7.5 billion and was the profit leader for the company.
The short term is uncertain for Disney just as it is for the rest of the world. If we were to bank on human societies figuring out solutions to the current crisis, there is no doubt that Disney is better positioned to bounce back once the tough times pass.
Market cap – $1.01 billion
52 week high/low – 7.90/3.32
Sandstrom Gold is a company not many investors have heard of. It’s probably the least well-known company on our list. The company is based out of Canada, and it represents a great way to invest in gold and mining opportunities. The business model of this company is known as gold streaming, and here’s how it works.
In the precious metals world, the practice of streaming refers to a company providing financing to a miner or driller. In exchange, the financing company receives the commodity that is being excavated. This practice has long been present in the oil drilling sector, where drillers face huge capital costs and an uncertain, fluctuating market for their goods.
They can spend a lot of money drilling for oil only to find that the market price for oil is low, and this leaves them with a massive hole in their pockets. Drilling for oil takes time and this causes a considerable amount of risk for drillers. This is where the streamer comes in.
The streamer pays the driller cash, and in return, the driller promises to sell the commodity to the streamer for a fixed price. This price is usually a percentage below whatever market value is present at the time.
This makes a lot of sense for the driller since they receive an immediate cash injection. From the streamer’s perspective, they’re receiving an asset that they can immediately sell back to the market for a profit. They’ll need to wait until the resource is available, of course but they don’t bare any of the costs of running a mine. A streamer can technically run their business out of their basement.
Gold streamers implement this business model in gold mining, and Sandstorm is one of the standout companies in this regard. The company was founded by Nolan Watson and David Avram in 2008, right when everything else was falling to pieces. 2009 saw the company ink its first two streaming deals.
Streaming deals take a while to start producing because the miner needs time to extract gold. To cover costs in the short term and to also provide financing for these deals, streamers borrow money from banks. However, due to the lack of cash flow from the mining assets, the company needs to find a way to pay interest on these bank loans. The result is that streamers issue equity or issue debt and bypass banks, to begin with.
There is a risk for shareholders that their shares will be diluted over time thanks to the issue of equity. Thus far, Sandstorm’s management has exercised great prudence and has managed its debt to equity mix admirably.
The stock was listed on the NYSE in 2012 and has carried out significant acquisitions since then. As of current writing, the company owns 191 different royalty streams and has a free cash flow of $225 million from 23 different gold mines.
So why should you invest in Sandstorm Gold? The more pertinent question to ask is, why should you be investing in gold streaming to begin with? Only once this question has been answered should we even consider Sandstorm as an investment. The first reason to invest in gold streaming is the business model itself.
Streaming companies are essentially a bank as far as miners are concerned. Traditionally, miners had to approach banks for short term loans and place their assets as collateral. This isn’t the case when it comes to sourcing financing from streamers. The streamer is a business partner in the deal since they are also exposed to the output from the mine.
This provides miners with a fair source of financing that doesn’t strain their balance sheets too much. After all, a miner’s financial position is risky, to begin with. Adding interest-based debt is hardly a sensible move. This means that the streaming business model will always be in demand. It has a strong moat, and a miner needing cash injections will always be on the lookout for a good streaming deal.
It isn’t easy to become a streamer. While you might think that anyone with oodles of cash can rock up and finance a mine, the reality of the business is quite different. To evaluate the potential of a mine, management needs to have significant experience in the field. They need to have experts on board who can reasonably assess the predicted output of the mine.
Only once this is done can any kind of financing terms be agreed upon. At this point, further experience is needed because there are various ways in which the deal can go wrong. For starters, the streamer needs to have a good idea of future commodity prices. They’ll be receiving the commodity in the future, so current prices don’t matter.
Next, they need to assess the capabilities of the miner. While the mine may be fit to produce gold, does the miner have enough resources to make this possible? Will the investment be enough, or will the miner need more? These are not easy questions to answer.
Our point is that the business has significant hurdles to jump over, and the economics of it is built for a small number of companies to dominate as long as they have management expertise. The quality of management is the most important thing since there are no traditional assets that the business owns.
However, this is a good thing because the lack of traditional assets means that overhead expenses are low, and as a result, free cash flow levels are high. There are no significant capital expenditures necessary, and this reduces the strain on the company’s financials. The only risk to mitigate is the waiting period between providing financing and receiving royalty payments.
As we mentioned earlier, streaming companies need to find ways to raise cash.They do this by either seeking financing from banks themselves or by issuing debt and stock. There are many ways to go wrong here and experience is what counts. This means that a company that has survived and thrived in this business for long is in a much better position to earn a profit and lower their risk than a new company. Experience really does pay off when it comes to streaming.
Thus, when looking for a company to invest in, it pays to evaluate management experience as well as the cash flow qualities of a company. In this regard, Sandstorm checks all boxes.
First, the deals it structures are intelligently done. The company structures what are called NSR deals. NSR stands for net smelter royalties. This means that Sandstorm provides financing based on the output of the mine and not on the viability of mining operations. There is a big distinction between the two. NSR royalties are paid on the basis of the output that comes directly from the ground. This what Sandstorm earns. The miner, on the other hand earns a profit only after they sell the gold to Sandstorm and subtract their own mining costs from this revenue.
In other words, Sandstorm is effectively buying shares in the mine’s deposits and isn’t concerned with the fortunes of the miner or the miner’s operation costs.
It completely cuts Sandstorm’s risk in terms of mining operations and ties it directly to the output of the mine. Since this is something that the company can evaluate well, it is playing within its field of knowledge.
Shareholder dilution is a primary concern for any investor and Sandstorm management is on top of this as well. The company has repurchased close to 10 million shares between 2018 to February 2020. With plans to repurchase even more shares given the depressed state of the market.
This shows both confidence in the company’s performance as well as a considerable reduction in dilution from an investor’s perspective. Given the current industry outlook, Sandstorm Gold is well set to dominate its niche for a long time.
Gold streamers have historically proved to be better investments than traditional gold itself. Gold is often used as a hedge within investor portfolios. If the value of the U.S Dollar decreases, then gold usually witnesses an upswing thanks to the correlation that exists between the two. Gold is viewed as a safe haven in tough times, and this is what causes the upswing in gold prices when the dollar declines in value.
Despite this, gold is a risky investment. Some supply and demand forces apply to it, but it is a tricky thing to predict. Between 2008 t0 2018, gold prices rose only by 45%. You’d have thought that gold mining companies would have been able to make money thanks to this, but in fact, their stocks were down 38% in this 10 year period.
In contrast, gold streamers’ stocks rose by an astronomical 189% during this time. A significant reason for this is all of the factors that we outlined previously. A built-in profit margin and low overheads turbocharge investment returns, and this is reflected in the rise in stock prices.
Market cap – $344.97 billion
52 week high/low – 128.08/96.79
Walmart is one of the mainstays of the American retail space. Industry experts have always worried about the ability of the company to overcome challenges, but the fact is that the company is still standing. More importantly, it has survived the gargantuan challenge that Amazon poses.
Amazon has succeeded in wiping out almost every retailer in America and continues to do so around the world, wherever it decides to enter. The fact is that not only has Walmart survived Amazon and the digital revolution, but it has also barely felt the impact of it. This is because it has a significant moat.
You might think that the brand name is what sustains it, but the real moat that Walmart has significant economies of scale. Its sheer size allows for it to take more substantial risks and reduce the economic impact of taking such risks. This, in turn, enables the company to achieve huge consumer satisfaction levels.
The advantage that Walmart’s moat gives it is that it is practically recession-proof. This was one of the few companies that actually managed to thrive during the economic crisis of the previous decade. Think about it: When times are tough, the first place you think about when it comes to grocery shopping is Walmart.
The current crisis will most likely lead to a recession. With more than 33 million unemployed in the US, the economic impact of COVID-19 is being felt far and wide. While Walmart’s physical stores might be closed, its online delivery system is in full swing. We’ll address this shortly. As of now, keep in mind that stores cannot remain closed forever.
Despite the challenges the COVID-19 virus brings, at some point, people are going to have to go back outside and buy groceries. When they do, they’re going to have less money on average than before, and the first place they’ll head to is Walmart. The store stocks virtually everything you can think of, and if saving money is the top priority, this is the place to head to.
Perhaps the biggest strength of Walmart is that 56% of its sales come directly from groceries and food sales. As you can imagine, the demand for this is unlikely to dampen anytime soon. The market prices of Walmart reflect this. While 2020 has been massively bearish for stocks as a whole, with the S&P 500 declining by 30%, Walmart stock declined by just 3.8% overall.
Not only is the company robust in tough times, but its stock also holds up pretty well, too.
Sam Walton was one of the first people to make economies of scale a business policy actively. What we mean by this is that while other retailers at the time focused on stocking goods and serving local customers, Walton realized the power of a chain store model where sheer size could allow him to dictate prices to his suppliers and thereby drive costs down.
This allowed him to open several small stores at first and essentially encircle his competitors. When it comes to shopping items such as groceries, consumers are incredibly price-conscious for the most part. Achieving economies of scale allowed Walton to address his consumers’ biggest need directly.
Consider that Walton managed to go from running a single store in Arkansas to running a billion-dollar company within his lifetime, and you’ll see the power of his business model.
One of Walton’s greatest innovations was to locate his stores in small towns at first instead of large cities. Conventional wisdom at the time was to locate big stores in big cities and smaller ones in small towns, thanks to smaller populations. Walton’s large stores managed to dominate not just a single town but the entire area around it. What’s more, the presence of Walmart discouraged anyone else from entering and thereby reduced competition.
Another innovation he pioneered was to insist on fast logistics. He did this by locating Walmart supply centers at less than an hour’s drive away from his stores and insisted on Walmart’s fleet of trucks supplying the stores to ensure speedy delivery of goods. This way, Walmart was assured of its prime position in the market.
This policy continues to this day. If anything, Walmart’s practices have only become stronger since the founder’s death. Warren Buffett is just one of many notable investors who made mention of this in 2006. Walton’s legacy lives on in his book, Sam Walton: Made in America, which continues to be one of the best business books ever written.
The principles that Sam Walton instilled in his company created a massive advantage for them, and it continues to power the corporation to this day.
Walmart has always been thought of as being late to the e-commerce game. However, in our opinion, this was simply the firm doubling down on its already strong business model and expanding only when it made sense. The majority of Walmart’s sales come from small towns to this day, and consumers in those markets do not traditionally purchase goods online.
This behavior is changing, and Walmart has responded brilliantly to it. As of this writing, online ordering and kerbside pickup is available in 60% of its stores. With this number projected to increase to 90% by the end of 2021. Despite this seemingly late entry into e-commerce, Walmart is still alive, while the majority of its competition is dying with e- commerce companies facing a raft of bankruptcies.
Most telling is the behavior of the giant that killed the competition: Amazon. Consider the fact that Amazon operates a very similar business model to Walmart but does it in the online space. It makes sense for Amazon to enter the low-cost grocery and essentials market.
Yet Amazon resists doing so. The company instead chose to buy premium grocer Whole Foods instead of trying to compete with Walmart in the budget grocery space. The fact that Amazon shied away from a direct confrontation is pretty telling. It communicates to investors that Walmart, despite all the gripes about the company being stuck in the past, is firmly entrenched in the hearts and minds of its customer base.
Walmart has expanded significantly abroad and has made repeated forays into the market that suits its business model the best: India. The government of India had to pass laws guarding the interests of small shopkeepers once news broke that Walmart was considering Indian investment. While it was a setback to the company, this event once again shows how pretty much no one wants to compete against this behemoth.
As of now, Walmart is operating in the country as a wholesaler. However, its biggest move there has been to acquire a portion of Amazon’s Indian rival Flipkart for $16 billion. The move initially didn’t make sense, but there are clearly echoes of its earlier investment in Chinese company JD.com in the Flipkart deal.
In China, Walmart operates online stores for small retailers as well as some of its competitors, such as British grocery chain Asda. In bigger cities, Walmart also runs hybrid online and offline retail stores where customers can scan and go. Clearly, Walmart’s move into the developing world is putting it ahead of the curve of many of its competitors.
The company is willing to go to any market as long as the terms of the deal are right. This could be in India or Vietnam. It doesn’t matter. Its strong balance sheet and hoards of cash ensure that Walmart will always remain in a strong position for the future.
The economies of scale that Walmart has pushed its brand value to stratospheric heights. This is a unique occurrence when it comes to chain stores. Every chain store retailer struggles against the brands it sells in terms of name recognition. For example, people know what Nordstrom is, but why would they go to Nordstrom in a mall that has Gucci and Versace stores as well?
However, this is not the case with Walmart. Consider this scenario: Let’s say there’s a brand of cheap cereal that is available for the same price at Luke’s Groceries and Walmart. Where will people go? Most likely Walmart. Even if the cereal company decides to sell exclusively to Luke’s Groceries, people will still flock to Walmart because that’s where you get all kinds of cheap stuff.
By choosing not to sell their product in Walmart, the cereal company is effectively removing itself out of its customers’ reach. It’s saying that it isn’t a budget brand anymore. In other words, it would be suicide for them to do this. This illustrates the moat that the Walmart brand has.
A similar phenomenon exists with its big-box retail outlet, Sam’s Club too.
All in all, the stock is not one of those high flying or sexy stocks that you can boast about owning. However, when it comes down to it, Walmart has all the qualities you look for in a good company and a stock that you want to hold onto for the rest of your life.
Market cap – $136.94 billion
52 week high/low – 221.93/124.23
McDonald’s might not be your preferred option when it comes to eating out, but this doesn’t mean it’s a bad investment. In fact, it might be one of the best investments you can find right now. First off is its track record. The reason McDonald’s has always performed well is due to its robust business model. We highlighted this in an example previously and will delve into it shortly in more detail.
The company has an enviable track record when it comes to providing shareholders with value. McDonald’s is a dividend aristocrat. This moniker is bestowed upon companies that have consistently made and increased dividend payments every year for the past 25 years. This is not an easy achievement, and it further indicates McDonald’s’ ability to weather crises.
Then there’s the appeal of the fast-food chain. Generally speaking, in recessions or downturns, fast food chains tend to perform well since they’re a source of cheap and quick food. Sit-down restaurants tend to struggle in contrast.
What’s more, McDonald’s has also invested significant sums into reducing costs even further by investing in AI and technology when it comes to the ordering process. There’s no denying that the COVID-19 prompted lockdowns have heavily hit the restaurant industry. People are staying and eating at home more than ever. Therefore, it is worth analyzing how McDonald’s is positioned regarding the immediate crisis as well as the repercussions of it that will occur down the road.
Let’s begin by taking a look at how badly operations have been hit due to lockdowns and closures of locations. In this regard, McDonald’s has suffered, but it hasn’t been as bad as you might initially think. This is because of three major factors that it has going for it. The first is the way the business is structured.
McDonald’s is in the real estate business as much as it is in the restaurant business. The company owns all of its locations and leases them out to franchisees for a high markup. This means that the company is guaranteed cash flow every month to a much higher degree than its competition.
As of current writing, as much as 85% of its outlets are franchisee operated. This means that the large majority of its locations are regular cash producers and the risk of the shutdown is primarily outsourced to the franchisees. While the company has announced plans to work with franchisees, the failure of a single franchisee simply means that there’s someone else to occupy the place. After all, the location itself isn’t in jeopardy. While there will be a short term cash hit, this has little relevance to the long term viability of the business.
Another advantage of this business model is that the company operates its restaurants at far lower costs than its competitors do. After all, it doesn’t bear any expense when it comes to utility bills or any other rental expense. The franchisee takes the costs throughout. In return, McDonald’s lends them the weight of their brand name and a large cut of revenues.
The second advantage is that the emphasis on fast food has allowed McDonald’s to build drive-thru outlets as well as implement a range of AI-powered ordering systems in its stores. For example, in specific locations in China, there is no need for a customer to interact with a human being. They simply walk up and place their order at a terminal and receive their food.
Drive-thrus are witnessing a huge leap forward thanks to self-isolation measures, and until a vaccine is found for the virus, this state of things is likely to remain. In 2019, McDonald’s reported that 65% of its sales in the U.S came from drive-thrus. This number is only going to increase. This means that the closure of seating areas are unlikely to have too much of a negative impact on earnings.
Another great move the company had previously taken was to partner with food delivery firms. Critics pointed out that McDonald’s didn’t have a dedicated partner, but, to be honest, this just reflects the fact that there isn’t a single company that has been able to dominate the niche. McDonald’s’s decision to partner with different firms is simply the company diversifying its risk across partners.
As of now, there are no predictions that can possibly quantify exact numbers from the effect this move has had. However, these factors make it likely that the negative impact of the virus will be blunted quite a bit when it comes to McDonald’s.
The economic impact of the virus is already being felt in the U.S. Unemployment numbers now top 33 million, and many businesses show no signs of immediate recovery. All of this points to the fact that there will be a recession. A bad one. So, how is McDonald’s poised to perform during these times? For starters, being a cheap fast food restaurant is going to work in its favor in the majority of the world. People are unlikely to stop eating McDonald’s just because times are rough. If anything, the opposite is the case.
Looking at the company’s performance in prior recessions is instructive. In the crisis of 2008, the company managed to increase its revenues every year from 2007 until 2011. The same happened once the dotcom bubble burst around 2000. McDonald’s increased its revenues like clockwork from 1999 until 2001.
An important point to note is that earnings growth rates didn’t match sales growth during these periods. This indicates that the company reduced its margins, but given the economic conditions, this is an understandable move. All of this points to the fact that McDonald’s is well poised to handle the upcoming economic recession, should it ever occur.
This is where things get a little risky with McDonald’s. At the end of 2019, thanks to major investments in technology and other assets, the company’s cash position was low. As soon as the lockdowns started hitting, this low cash position became an even bigger concern thanks to the decrease in revenues.
This prompted the company to withdraw its $1 billion credit facility. A credit facility is like an overdraft account that companies can borrow from. However, the fact remains that it has $34 billion in debt on its balance sheet, with $6 billion coming due in 2023. This payment might prove to be problematic for management.
There are no easy solutions for its debt problem, despite experts noting that it fully expects McDonald’s to pull through this time. However, companies the size of McDonald’s have greater power to renegotiate payment terms and kick the can down the road until a moment when revenues stabilize. This is likely to with the 2023 payment.
This year is going to be a tough one for McDonald’s as it will be for the rest of the world. How well the business model manages to support McDonald’s remains to be seen. There’s no doubt that it will ensure that McDonald’s navigates these times with more certainty than its peers.
Another important factor to consider when it comes to McDonald’s is its dividend’s status. Any suspension of a dividend will result in it losing the aristocrat label, and this will result in a downward plunge in stock prices.
As of this writing, the company has suspended its stock buyback program.This is probably in order to save cash for the dividend payment and to increase it by marginal amounts. Generally speaking, the company has weathered crises in the past, and as such, one can expect it to pull through, even though the short term picture is uncertain.
The company’s biggest issue happens to be its high levels of debt which has placed it in a tricky situation right before an unforeseeable crisis. Despite this, it is well placed to handle tough times. Even if the worst does happen and earnings plummet, the company is still a real estate giant that owns all of its properties.
It is not going to lose locations just because it cannot pay the rent. It is free to find different ways to boost revenues, and the increased cash flow will enable it to survive on shoestring margins. Think of it this way: As long as it pays all of its creditors, does the existence of a profit matter all that much? We’re not saying that the company will deliberately run a loss.
The point is that even the worst-case scenario is not going to result in as much pain as some of its competitors will feel during the next few years. All of this makes McDonald’s a safe haven stock that is most likely going to be around and thrive for a very long time.
Market cap – $13.86 billion
52 week high/low – 1347.64/710.52
Typing Markel into Google usually results in the search engine asking you if you meant to type ‘marvel’ instead. This is a pretty apt way to describe what Markel is all about. It is one of the biggest companies on the planet no one knows, and this is a very good thing. Markel has been dubbed ‘the baby Berkshire’ due to the similarity between the way it is structured.
Markel is an insurance giant, and it began its life as a specialty insurance company for long haul truckers and jitney buses in the 1930s. Specialty insurance is an excellent field for many companies to carve a moat in because the number of customers that require such insurance is low, and any company that can successfully underwrite policies tends to be quite successful.
The insurance business itself is an immensely profitable one, and it is one that a lot of professional investors seek to get into. The famed founder of Stansberry Research, Porter Stansberry, once quipped that insurance was the one business that he would teach his children. Despite this, the average investor doesn’t truly understand the power of the business. In order to fully understand the potential of Markel, we need to first examine how the insurance industry works and why it is so desirable.
An insurance company writes policy and receives premium payments like clockwork in return for promising to pay a sum in case things go wrong. The sum that needs to be paid is usually far more than the premium that is charged. The insurer’s job is to figure out how much risk they’re running on the policy and accordingly price their premiums. However, they can’t price them too high because their competitors might undercut them.
If a policy expires and the company has to never payout, this creates what is called an underwriting profit for the company. An underwriting profit is a unicorn for insurance companies since they’re notoriously difficult to come by. It’s tough to predict risk after all, and at some point, the insurer has to pay out the amount for which the policy is insured.
This is why most insurance companies don’t even try to earn an underwriting profit. Instead, they aim to breakeven or even run a loss in order to simply capture market share and keep the cash flow levels high. Now, there is usually some period of time between receiving premium payments and having to pay out the insured sum.
For example, you make health insurance payments every month, but it’s not as if you’re going to claim benefits every single month. You’ll most likely claim them at some point down the road. During this time, the insurance company gets to keep your cash without any obligation to return it. This money is called float.
If the company manages to secure an underwriting profit, it creates a free float. In essence, a free-float is simply free money. Insurance companies that don’t generate a free float can still earn a profit. They do this by investing the float into the market. In short, they act as fund managers and aim to generate returns with all the cash that they have lying around.
Many insurance companies rely on generating profits with the float they have instead of underwriting. The best companies such as Berkshire Hathaway and Markel tend to produce both investment returns as well as underwriting profits. This creates a free-float that effectively leverages their investments.
Think of it in this way. Let’s say you buy stock A for $100 and it pays you $25 in cash dividends. You reinvest this $25 into another stock B that pays you $10 in cash. You reinvest $10 into C that pays you $2 and so on until you’re invested in a number of stocks. However, your original investment amount is still $100. You’ve turned $100 into an investment into at least four stocks that have spawned even more investments.
Float creates leverage as well, but since this isn’t free money, the overall returns are hampered a bit. The company needs to pay this amount back at some point since their customers will make claims on their policies. In essence, the float a company carries is a short term loan to the insurer, and a free float is a loan that never has to be paid back.
Markel is one of those insurers that understands the power of cash flow and practices this with its own investments.
Quality of Investments
Markel’s portfolio over the years has reflected management’s philosophy that businesses that generate a high degree of cash flow are the best ones to invest in. In fact, management is so confident in their ability to pick investments that they don’t pay dividends, which is unusual amongst insurers.
Typically, the free cash flow that an insurer generates is returned to the shareholders since the company cannot find adequate uses for it. However, Markel has successfully used its free-float and cash flow to increase its holdings in its portfolio and deliver even greater returns to its shareholders.
When speaking of Markel, special mention must be made of the quality of the shareholder base that the company has. The company seems to have a high number of shareholders who are focused on capturing long term gains through their investment and, as such, are willing to stomach a few negative quarters or two.
I say quarters and not years here because the average public company faces intense scrutiny after a few quarters of losses. Wall Street gangs up on them and this forces management to place short term results above long term growth as we explained previously.
This is not the case at Markel since there aren’t any agitators present. As such, the company is run like a private company. Where the business aims are aligned with the long term growth of the company.
Property and casualty insurance remains the primary driver of the business, and these are great niches for Markel to operate in. This is because the company faces little competition and it has a great deal of pricing power. This is a direct result of excellent customer service and competitive pricing that keeps competitors out as well as ensures a moat for the company.
It’s not all great news with Markel, and there are some risks you need to be aware of. All of these risks typically center around the reinsurance business. Reinsurance is insurance for insurance companies. For example, if insurance company A decides that it has some pretty risky contracts on its books, it approaches a reinsurer to insure those contracts.
As you can imagine, reinsurance is a pretty risky business. The biggest risk here is the fact that all of the situations that the company has to insure are so-called long-tail situations. A long-tail refers to the fact that payouts can occur many years into the future, and when they do, they tend to be substantial.
Thus, a reinsurer can carry a huge amount of risk on their books without ever knowing the true cost of the policy until the time comes, if it ever does, to pay. Typically, reinsurance policies are sought for extreme events such as a global pandemic like the one we’re living through right now.
How does one estimate the odds of a disease spreading like wildfire? Furthermore, how does one even begin to calculate the economic impact of such pandemics? It depends on the disease of course. How can anyone predict what kind of a disease might occur next? These are impossible questions to answer.
Reinsurance company underwriters thus need to be masters of risk management, and they need some luck on their side as well. For the most part, reinsurers generate high levels of free float, but when they do find themselves in a position of having to pay, they end up draining their cash reserves and going into the red. The levels of losses they typically sustain cannot be compensated by the returns they receive from the free float.
Even the esteemed Berkshire Hathaway has been burned at the reinsurance game a few times, and Markel is no exception. Insurance companies use a metric called the combined ratio to calculate their profit and loss levels. This is calculated by dividing the total expenses and losses incurred by the premiums earned.
The smaller the number is, the greater the profit is. Markel’s combined ratio for 2019 was a healthy 93%. This means that expenses were 93% of premiums earned which means they earned a good amount of free float. However, this clouds the fact that the company’s reinsurance division posted a ratio of 120%.
It was property and casualty that brought that number down to 93%. You might wonder why a company would even consider entering the reinsurance game if it’s so risky. Well, it has to do with the rewards on offer. It’s a bit like asking why would you borrow money to buy a home. The value of the asset and security makes up for it.
The prospect of the value of the home decreasing is just a risk you have to take. It’s the same with the reinsurance business. Having said all of this about Markel’s reinsurance business, it must be noted that the managers of the company have wisely minimized the effect of it on their overall portfolio.
If a 120% combined ratio in reinsurance still results in 93% overall combined ratio, then this is a risk that the company can justifiably take.
Smart management and a carefully engineered moat make Markel is a fantastic company for the long term and a great addition to any portfolio.
Market cap – $86.71 billion
52 week high/low – 99.72/50.02
Starbucks has been an interesting case study to evaluate how companies will perform during these tough times. This is because the two biggest markets for Starbucks happen to be the US and China. Given the global situation, Starbucks was one of the first major companies to get hit with store closures and self-isolation measures.
Given that the Chinese situation is ahead of the rest of the world at the moment, in terms of recovery, the initial for Starbucks made for interesting reading. First off, the company announced that while sales dropped disastrously during the first quarter of 2020, there was a growth in-store visits as lockdown curbs eased.
The picture isn’t all that great, but it does prove that the business model of Starbucks is still very much viable. The company might be in the coffee shop business on the surface but its real appeal lies in the fact that it is a great third space for people to meet. Whether it is to meet for a date or a business meeting or even sit and work, Starbucks is an obvious choice for most people.
The company is coming up on its 50th anniversary next year and in 2019, it opened 1,439 new stores worldwide. As the year ended, the company reported an increase in same-store sales to the tune of three percent. Then the virus hit and things took a turn for the worse. The biggest gripe about Starbucks, from people who don’t understand the business, is the fact that it has always been a bit too luxurious a brand to appeal to people during a recession.
The price of a single cup of Starbucks coffee has always been on the higher side. Paying $5 for a single cup does sound ridiculous when compared to its competition but people pay this amount for much more than just the coffee. The ordering experience and ambiance are what people really pay for.
There are a number of factors that ensure that Starbucks is well placed to handle the tough times ahead.
As we just mentioned, people who drink Starbucks coffee usually drink only Starbucks coffee. The addition of food options to the menu in recent years and the general ambiance of their locations means that customers tend to return to the location more often than not.
Starbucks is one of those rare companies that rewards its customers back once they’re shown loyalty. The rewards program is one of the most generous and is a drawing point for many new customers. Apart from having the ability to order ahead of time, rewards program customers also receive free refills of hot coffee or tea in-store.
Customers in higher tiers receive free snacks and food as well, and this guarantees that they’ll always be back to visit. All in all, the company has brand loyalty figured out really well, and this will keep it in good standing through tough times. On the surface of it, closure of shop locations will hurt sales. However, once lockdown curbs ease, people will be keen on socializing once more.
Given the negative impact on their wallets, spending $5 for a cup of coffee and chatting at a Starbucks is a pretty cheap way to socialize. The coffee might be expensive, but the purpose of a customer’s visit isn’t to just have a cup of coffee.
Much like with McDonald’s, it’s instructive to take a look at how Starbucks managed to handle the previous recessions. Here, there isn’t as much of a track record we have to play with. The previous recession coincided with the business model of Starbucks circling the drain as well. The company was in trouble headed into the recession and the crisis only made things worse.
The return of Howard Schultz, the founder, as CEO helped get things back on track. Starbucks embarked on an unprecedented program of winning back its customers’ trust. It began with a series of surveys and questions that the company asked its customers concerning the customer experience.
The response was tremendous and the company carried out many of the recommendations that its customers wanted. It remained one of the few instances when a large public corporation gave its customers free rein when it comes to suggesting improvements and directing the course of the company. All of this helped Starbucks exit the crisis in much better shape than how it entered it.
Will the same experience help the company this time around? The exact steps it took last time might not apply during these times because the nature of the crisis is different. During 2008, customers were dissatisfied while this time around, this doesn’t appear to be the case.
What will stand the company in good stead is that its focus on customer loyalty has paid off massively, and this has led to a strong brand presence. This is a very good thing when it comes to handling tough times. While there’s no way to predict how the company will handle the recession, its focus on its customers does put it in a good place.
While the brick and mortar locations remain Starbucks’ primary earners, the company has been diversifying to create additional revenue streams. One of the side effects of brand loyalty and recognition that was born from the previous crisis is that it enabled the company to sell its brand of coffee in supermarkets.
This brought in a decent chunk of cash, and while this isn’t nearly enough to sustain the company all by itself, it does dampen the negative impact quite a bit. In addition to this, Starbucks has partnered with several delivery companies and has been expanding its drive-thru and mobile ordering platforms.
All of these platforms will see increased consumer interaction as buying habits chance post this crisis.
All in all, despite having many factors working against it, Starbucks is a company that is poised to break out once the lockdowns end, and people begin to adjust to the new economic and social reality that the virus will bring about. The short term might be painful for investors, but the long term does promise stable growth.
Crown Castle International
Market cap – $68.41 billion
52 week high/low – 168.75/114.18
Crown Castle is a relatively unknown stock thanks to the fact that it happens to be a real estate investment trust or a REIT. These companies don’t have to pay corporate taxes but are obligated to return 90% of their profits to their shareholders in return. Typically REITs invest in real estate assets and make money by managing those properties.
REITs have become increasingly popular over the past five years. Crown Castle is a specialized REIT that doesn’t invest in the usual residences or commercial spaces that are associated with these instruments.
Instead, Crown Castle is a cell phone tower REIT. As the name suggests, the company owns a number of cell phone towers around the country and also manages miles of fiber optic cables that enable communication. In short, this company is a service provider to one of the fastest-growing phenomenon in the world currently: The internet of things.
This phrase is used to signify the increasing degree to which everything in our lives is connected to one another. Each day witnesses new smart devices being launched and the day isn’t far off when our vehicles will be able to communicate with our devices at home and exchange data.
Wearable tech such as the Fitbit and other smartwatches have witnessed huge increases in demand during this decade and this will only continue to grow. The IoT economy is projected to reach up to $11 Trillion by 2025.
All of these devices need one thing in common: A network. To be precise, they need a network that can handle the increasing number of connections and data being exchanged. This data will need to be transmitted faster and with more efficiency than current networks can handle. Communications protocols aren’t far behind at the moment.
4G networks were a huge step forward in terms of reducing latency (the delay between sending data and receiving it), but they cannot handle the rate at which connections are increasing. 5G communication networks are already being set up and the world needs the faster speeds that 5G promises.
While more research is needed, the fact is that existing communication towers and infrastructure are capable of handling 5G’s demands. With the number of people connected to the internet only set to increase, communications businesses are a great bet for the future.
This is where cell phone tower REITs come in. These companies earn income by leasing towers to operators and earn a steady income for the lease period. On average, the lease period lasts for five years. In addition to this, these companies also lease their fiber-optic communications facilities to network providers for a fee.
All in all, the future is bright for the industry. The question is, why is Crown Castle the best bet of the lot?
The first cell phone tower company to convert itself into a REIT was American Tower. This is the best known company of its kind, and since 2011, which is when it became a REIT, the company’s stock has returned well in excess of 300% (DiLallo, 2019).
Crown Castle turned itself into a REIT in 2014 and since then has returned 140% for its shareholders. While AMT is the more prominent company, Crown Castle happens to have far better growth prospects. What’s more, since it’s a REIT, it is legally obligated to pay out 90% of its income to its shareholders. This means that its dividend yield is higher than the average dividend-paying stock.
As of current writing, the yield on Crown Castle is 3.05%, which is double the size of American Tower’s yield. This makes the company an income earner as well as a capital gains machine.
Currently, almost all of Crown Castle’s infrastructure is located in the United States which means it has a stable business environment to work in and doesn’t need to worry about international laws and licensing. This is in contrast to American Tower, which operates internationally.
A third cell tower REIT, SBA Communications is also operating internationally thanks to saturation in the American market. This is good news for Crown Castle since its existing infrastructure is unlikely to be disrupted anytime soon.
The company, as of December 2019, has 40,000 towers and 80,000 miles of fiber networks. The business is simple to understand. There are just two divisions: Towers and cable. Operating costs are low and are usually front-loaded when networks and towers need to be installed and brought online.
These costs are typically lowered by adding more tenants to existing infrastructure and thereby reducing unit costs. The addition of more tenants usually boosts operating cash flows quite a bit because costs are low, to begin with, and they dramatically reduce once this happens.
40% of gross income from the towers segment is derived from the land that the company owns. As for the remaining 60%, the average remaining life on the land leases are 35 years long. The largest cell phone companies in America account for 75% of revenues, and there isn’t any danger of default with regards to payments. As of now, the towers division is the primary earner with 67% of income derived from it.
As of 2019, the company has invested money into developing its fiber business and they expect income to rise in forthcoming years. Given the demand that 5G is going to place on fiber networks, this seems like a reasonable assumption to make.
Cash Flow Growth
Crown Castle is one of those companies that is poised to make huge growth. As of this writing, the company is about half the size of its competitors but owns a wide variety of great assets across the United States. According to the company’s latest annual report, 71% of Crown Castle’s towers and fiber networks are present in major business areas around the country.
Given the increase in demand that 5G will bring and the high quality of its assets, investors can expect high levels of cash flow from the company. As such, cash flow has grown at a faster pace thus far when compared to its competitors. A lot of this has to do with the smaller size, and investors cannot expect the same growth rates as the company gets bigger.
However, there is a significant runway for the stock to grow. And the economics of its business seems to be lining up well in this regard.
No investment is without risk, and Crown Castle has inadvertently stumbled upon a huge risk thanks to the current political climate. 5G finds itself at the heart of the US-China trade war because of the potential it has to unlock greater levels of data transfer. As such, China is considered to be the leader in developing 5G technology, and one firm is the leader when it comes to developing electronic equipment that suits 5G.
This company is Huawei, which found itself being accused of being a spy front for the Chinese government. Right now, Huawei is banned from conducting business in America, and American companies cannot supply or use any of their products. However, this is not the case worldwide.
European governments, in particular have had no qualms about installing Huawei equipment and have resisted American attempts to move away from the company’s products. It doesn’t help that there isn’t a single American company that has the capabilities to develop these products.
The Trump administration, and the Chinese government, view 5G as being the key to global dominance. Given China’s massive investments in this technology, it could conceivably dominate the market, and this will result in every technology company using Chinese products to transfer data and conduct business. This is where allegations of spying come from (Rydon, 2020).
While the specifics of the trade war are immaterial here, what investors should keep in mind is that there are likely to be second-order effects on cell tower REITs such as Crown Castle. At this point, we can’t predict what these effects will be, but unforeseen circumstances might impact their business.
Right now, the major American carriers have stated that they do not use or plan to use Huawei or Chinese products in their 5G infrastructure. Given that 5G has barely been rolled out as yet, this claim will be tested in the coming years. Will Crown need to upgrade its infrastructure? Will it need to invest more in installing fiber networks? There is a significant risk here to cash flow growth.
This is not to say that the company is going to make a loss due to these risks. After all, 5G demands pretty much the same infrastructure as 4G does. You can think of both networks via an analogy: 4G is a collegiate swimmer while 5G is Micheal Phelps at his prime. The latter is a lot faster, but ultimately, both of them swim in the same pool. Crown Castle is the pool in this case.
A bigger risk to the company than the trade war is the fact that 70% of its revenues come from the major carriers. Any consolidation of these networks is going to reduce its earnings. In fact, T-Mobile and Sprint agreed to merge in 2018 and are in the process of completing the merger. While the impact on Crown’s revenues won’t be as large, there will be some decrease as overlapping networks get eliminated.
Companies such as Crown tend to grow via acquisition for the most part and disruption to revenues might impact this. While the company has enough cash to fuel growth, it might find that acquisition is not the most practical thing for it to do. Given that there are no other ways for it to grow, this puts it in a sticky situation.
We say that there are no other ways to grow because practically speaking, it takes time to buy land and to erect a tower manually. While a company spends a few months doing this, a competitor can go out and buy another company and instantly add a few 100 towers to its portfolio.
Despite these risks, the quality of Crown Castle’s management and its track record proves that the company can weather these storms. The growth in cash flow and the upcoming demand for 5G is certain to fuel overall growth, and Crown is in pole position to lead the way in this sector.
Market cap – $1.19 trillion
52 week high/low – 2475.95/1626.03
From a company very few have heard of, we move onto a company that even your technophobic grandma has heard of. Amazon is everywhere these days, and that is not an understatement. It has become the second company to reach the one trillion-dollar market valuation mark and joined Apple at this spot.
Amazon started off as an online bookseller but has since taken that business model and has replicated it over and over. It begins by raising a war chest through financing. In its earlier days, it did this by venture capital funding. Once this was done, it slashed prices to such an extreme that the competition was forced to quit or risk bankruptcy.
Having gained close to complete market share, the company then consolidates and adds other products to its offerings and generates more lines of cash flow. In its early days, Amazon was all about cash flow and not earnings. In fact, it took Amazon a long time to post a profit, and the business model was questioned widely at the time. The logic was simple. As long as Amazon could fund its expansion with other people’s money (venture capital or equity and loans at low-interest rates), and it could pay its expenses, profits didn’t matter.
Profits would eventually come when the company reached a specific size where customers would automatically turn to it. This model has repeated over and over again with every single business Amazon enters. The second major business the company entered was IT infrastructure with Amazon Web Services or AWS.
AWS offers cloud-based data centers and a number of large companies such as Zoom and Slack use it as part of their daily business needs. As Amazon expanded into more product segments, the same formula was applied over and over, and gradually, the older business segments began turning a profit.
Today, as the company continues to expand, it doesn’t need to raise additional cash because its existing lines of business provide it with all the cash flow it needs. It has even helped Jeff Bezos fund personal investments such as buying the Washington Post newspaper and founding a space rocket company.
Amazon these days has a wide and varied product line. The most prominent one is Prime membership, and this is effectively a loyalty program. Prime membership gives its customers access to discounted rates and offers on a number of products and also includes Prime TV access which is Amazon’s streaming service.
The company has stayed true to its roots in book retailing and has a vast library of eBooks and paperbacks. Amazon’s self-publishing platform incentivizes self-publishers to churn out hundreds of thousands of ebooks every year, and with the acquisition of Audible, Amazon has diversified its book offerings. All of these platforms represent a source of recurring revenues for Amazon.
Amazon’s technological forays include developing the Echo home device with its assistant Alexa. This helps amazon collect all kinds of data about consumer behavior that helps tailor product recommendations on the platform.
In addition to this, Amazon has expanded into the grocery business by buying Whole Foods and developing its own pay and go stores. To help support these stores, Amazon has developed a patented Just Walk Out or JWO technology that is still in its early stages of maturity.
As of now, the only customers for this tech are Amazon’s own stores, but in the future, it isn’t inconceivable to see it spread to smaller and medium-sized retailers everywhere.
In its early days, Amazon’s financials were under constant scrutiny and justifiably so. Bezos’ strategy of minimizing earnings at the expense of cash flow was risky, but it paid off. The margin of error was small, but to his credit, he pulled it off, and Amazon is now well within safe territory.
The firm has a good amount of cash, and given the events of the crisis, it should only see increased activity on its website. Amazon is already the biggest shopping search engine on the planet, and this number is only going to grow. What’s more, its free cash flow (which is the cash left over after all operating expenses and investments are deducted) has also steadily increased since 2017, which indicates that a number of its internal investments are nearing maturity.
This means the company can expect an earnings boost in the upcoming decade. The sheer extent of the number of products it offers as well as the multiple businesses it is involved in making sure that Amazon is going to find it close to impossible to fail.
Impact of COVID-19
Amazon has not been spared from the impact that the virus has had on the world. The primary casualty has been the delivery services that are offered with Prime membership. Typically, members receive their orders the very next day. However, with the crisis unfolding, Prime orders are being delayed by up to a month.
Amazon has made it clear that they are prioritizing the shipping of essential items above all else. This is probably what has led to alarming sounding numbers like that, but there is no doubt negative impact at the moment. Given its sheer size, one would expect Amazon to recover in short order.
Given the changing behavior of consumers that once can expect in these times, the development of JWO is great news for the company. While its competitors, such as Walmart and Target are unlikely to implement it thanks to data sharing concerns, Amazon is likely going to find several businesses interested in the software. It helps minimize human contact and removes the need for workers to be in harm’s way.
The other line of business that is likely maturing at just the right time is digital advertising. As Amazon’s platform has grown, it’s advertising services have famously lagged. For the longest time, Amazon’s marketing services AMS was the most unsophisticated platform when compared to Facebook or Google’s platforms.
This has changed rapidly over the past two years, with digital revenues now significant enough to warrant a mention on the quarterly earnings call. As more shoppers turn to Amazon, targeted advertising offers a great way to boost earnings, and here, Amazon is primed to take advantage.
Amazon’s success is often ascribed to its CEO Bezos and this is largely true. His management style has been described as prickly and lacking in any sort of empathy. However, his results speak for themselves, and to his credit, Bezos has never been involved in any scandal or dishonest business practice during his career.
Bezos’ vision is what ultimately drives Amazon and forms the biggest reason to invest in the company. Much like how Steve Jobs was Apple’s biggest economic moat while he was alive, Bezos has created a similar situation for himself and his company.
While he isn’t the most forthcoming with his vision, it is safe to say that he has built enough of a track record to justify investing in Amazon. Warren Buffett seems to think so as well with his recent investment in the company. Despite his dubious record when it comes to managing his own employees’ wishes, there is no denying that Bezos places customer satisfaction at the top of his list and is willing to go to any extent to satisfy their concerns.
In fact, Bezos has managed to create a truly unique economic moat for his company, and it is one that few other CEOs have succeeded at creating.
Given that Amazon straddles so many different lines of business, it is staggering to think of how varied and diversified its moat is. The first and most apparent moat it has is its economies of scale. Amazon is so large and their pockets are so deep that they can afford to drive prices as low as possible and still make a profit.
This is impossible to match, and perhaps Walmart is the only other company on the planet that can do this in the consumer goods segment. However, Amazon does this with every product on its platform. A side effect of this is that it manages to generate large user numbers.
With a large number of users comes data, and this is at the heart of how Amazon does business. The mountains of data that Amazon has, be it from customer behavior on its platform or through digital ads or through AWS, Amazon gets to use this as a free float of sorts to deliver an even better experience. In short, it receives perfect customer feedback all the time, and thanks to user volumes, its competition cannot even hope to match it.
Lastly, there is the one that the Bezos himself creates. As we just mentioned, he presents a great reason to invest in Amazon all by himself. These three moats combined create a pretty unique opportunity for a company in this day and age. Even Google doesn’t have the diversity of data that Amazon has.
All in all, Amazon is a no brainer investment for the future and is one that will only grow from here.
The Trade Desk
Market cap – $9.74 billion
52 week high/low – 323.78/136
Here we have yet another billion-dollar company that some experts call “the next Netflix.” The Trade Desk (TTD) operates in the B2B advertising space, and as such, its business model is likely going to intimidate a few investors. However, the model itself is simpler to understand that it seems on the surface.
TTD is what is called a “buy-side advertising enabler.” This means that if you work for an ad agency and are looking to buy advertising space across different forms of media, you can log in to TTD’s platform and instantly purchase slots. In the past, given the dominance of television networks, ad buyers used to negotiate with the networks directly.
These days, there are many more ad platforms, and thus, there is a need for a single consolidated platform that allows buyers to buy space and thereby plan their budgets more effectively. The old process used to take time, and this is another benefit of a platform like the one TTD provides.
There are many platforms that do what TTD does; however, the business models are fragmented. What this means is, there is much variation between how these platforms do what they do. TTD positions itself as a platform that is solely focused on the buy-side and does not favor any sell-side network. This helps it avoid any conflict of interest.
After all, favoring a particular seller might result in a poor experience for the buyer and even worse, cost them money. The ad industry has traditionally been a buyer’s market thanks to the increasing number of sellers. After all, the number of TV networks grows every day and these days; streaming platforms sell space on their networks as well.
Thus, TTD has positioned itself as a trustworthy name in the industry, and this gives it a significant moat in the minds of buyers. The company divides its operations between two categories, informally speaking. The first is what it calls ‘linear TV’. This refers to selling ad space on television channels.
Despite the increasingly bleak prospects that cable TV faces, the fact remains that audience numbers are still high. However, it is a highly inefficient market since advertisers cannot collect data or measure the success of their campaigns to a large extent. After all, how can you measure whether someone saw your ad and decided to buy your product if they saw it on TV?
The second line of business is what TTD calls connected TV or CTV. CTV refers to digital advertising platforms outside of Google and Facebook, which are heavyweights in the industry and handle their buy-side all by themselves. What we mean by this is that both companies allow ad buyers to create their accounts and manage everything themselves after analyzing the mountains of data provided to them.
TTD sells ad space on platforms that are outside of these two tech giants. For example, ad space on Hulu is sold through TTD. A number of other streaming services advertise their space on TTD’s platform as well. It is in the CTV space that the company stands to make explosive growth.
The modern ad world is vastly different from what it was just a decade ago. Back then, ad agencies mostly focused on the creative side of things and used disciplines such as psychology to drive their ad campaigns. These days, advertising is a matter of data crunching.
Pretty much everything can be tracked and interpreted, and as a result, human psychology can now be quantified. A good example of this is how advertisers run A/B split tests where they test different versions of ad copy to measure what works best. The ad executives don’t need to guess what will work anymore; they can measure it.
This has led to increasing demand for data from buying platforms. TTD shines in this regard since it is a fully customizable and open platform. This means users are free to add whatever module they wish and can customize tracking metrics. In contrast, even platforms such as Google and Facebook aren’t open or customizable. You’re stuck with whatever metrics they provide, and that’s it.
The customizable nature of TTD has allowed it to stay ahead of its competition, which provides similar facilities to varying degrees. Add this analytical ability to the growing relevance of CTV advertising, and it becomes obvious that TTD is well-positioned to take over a still-nascent market that is growing exponentially. The CEO of TTD, Jeff Green, had this to say recently about the nature of the ad buying industry (Zafar, 2020):
“…the TV ecosystem today, we think of as a little bit of a ticking time bomb…in traditional TV…the users are going away, the number of people watching is declining, but the cost of providing the service has been going up. And the price of the ads has been going up, even though fewer people are watching…so that’s making it…less effective on a per-dollar basis than it has been.”
This proves that the company is headed in the right direction by ramping up its focus on analytics and customization.
Another aspect of buying patterns that the ad industry is witnessing is the growing need for automation. This is commonly referred to as programmatic ad buying. Programmatic buying is an algorithm-driven process where advertisers can input their desired criteria, and the algorithm goes ahead and bids and buys whatever space is available. This creates greater efficiency in the process since the algorithm can assess which space offers the greatest cost to benefit ratio.
The increased use of analytics in the ad industry has led to buyers becoming ever more cost-conscious, and programmatic ad buying is at the forefront of their needs. A data-driven platform, such as the one TTD provides is necessary for advertisers to tweak their automated ad buys and create greater efficiency in their bidding process.
A neglected fact of digital advertising is that many countries in the world are lagging behind the technologically mature markets in terms of infrastructure available and analytics spend. This presents huge opportunities for companies such as TTD to expand their reach.
Having access to data in more sophisticated markets will allow buyers in less developed ones to place more intelligent buys. Think of it this way: If you’ve ever tried to advertise on Facebook, you will have noticed that the cost of acquiring an American customer is far greater than acquiring one in Denmark.
This is because there is far less competition in the Danish market, and as a result, you receive more bang for your buck. If you cut your teeth in the American market, dominating the Danish space will be easier. This is pretty much what TTD allows advertisers to do by providing them with relevant data measuring capabilities.
In particular, the company plans on expanding in China and Indonesia, where it believes massive growth potential exists. This is something that no other competitor has managed to pull off and TTD’s growing presence in the traditionally sealed off Chinese advertising market is cause for optimism for investors.
TTDs clients are spread out across the board and no single client represents more than 10% of revenues. Two clients currently represent more than 10% of total billings, and this number is down from three in 2018. What’s more, the company has a client retention rate of 95% over three years from 2017. This is a great sign since the more diversified a company’s client base is, the less it depends on one customer to generate revenues.
There are a few risks that investors must make a note of when it comes to TTD. The business is a highly technical one, and as such, all tech-driven businesses are open to disruption. TTD is no different in this regard. It is operating in a space that is still immature (programmatic buying), and this market will evolve in ways that management cannot always predict.
The other thing to keep in mind is that TTD is a relatively immature company compared to the other recommendations in this list. It is operating in a highly competitive market, and any loss of technological ability will result in it losing its moat extremely quickly.
Then there’s the fact that some of TTD’s competitors such as Google’s marketing platform and Verizon Media have better resources than them and could decide to enter the space and introduce more innovation at a rapid pace, which TTD cannot handle. Alternatively, it also means that TTD could be the target of an acquisition. This is not a negative, to be clear. Acquiring TTD would be a smart move on the part of a large competitor at this point, and shareholders will likely see significant gains if this happens to pass.
As such, keeping these risks in mind is prudent, and none of them dampen the case for investment in TTD. The stock is set to skyrocket and is a growth stock in every sense of the term.
Market cap – $17.34 billion
52 week high/low – 110.00/71.03
Keysight is one of those companies that is integral to almost every single company out there. This is because it is a manufacturer and supplier of 5G chips. It also makes software that is used in every industry from aerospace, auto manufacturing to defense. The primary investment thesis of investing in Keysight is the same as the lesson that was learned back during the gold rush.
The gold rush inspired tons of people to move out West to seek their fortune in desperate little mining towns in the middle of nowhere. The odds of the prospectors being successful was low thanks to the large competition that faced them. Enough movies have been made about what these men went through.
What is not mentioned, is that there were people who became extremely rich off the gold rush. It wasn’t the prospectors but the saloons and prospecting equipment sellers. In other words, during the gold rush, the only people who became rich were the ones who sold shovels and booze. This thesis of investing has been reliable throughout the course of history
and is the basis for our 2nd and 3rd order consequences cornerstone.
Instead of investing in a hot niche that is crowded with competition, it’s far better to invest in companies that are suppliers to the hot niche. The supplier is sure to benefit from the huge demand that will flow to them thanks to the number of companies in that niche.
A good example of this thesis are companies such as Keysight and Intel. These companies don’t manufacture the finished products but make products that are integral to those finished goods. Every electronic item out there needs a chip. While Intel focuses on producing chips for computers and smartphones, Keysight focuses on chips for industrial purposes.
This is what has led the company to establish a broad customer base, and this is unlikely to change. The niche that Keysight operates in has high barriers to entry thanks to its being a hugely technical field. Furthermore, the established nature of Keysight’s business means that competition is unlikely to win over too many of Keysight’s clientele.
The company began life as a subsidiary of Hewlett Packard and was spun off in 2012. Thus, while its life as a public company is short, its expertise stretches a long way back. This is what has enabled it to grow spectacularly since its formation, and it has avoided the usual hiccups that new companies face.
Keysight’s business is grouped into three different categories. The first is the communication solutions group and this group serves the aerospace, dense, and government industries. One of the key drivers of growth here is the rise of 5G, as well as the growing complexity of semiconductor devices as automation grows. The group’s products find their way into products that are used for communication, satellites, radar, and surveillance systems. This group raked in $715 million in profits during the previous year.
The second division is the electronic industrial solutions group, and the profits for this group come in at $294 million. The group’s focus is on consumer technology, and in this regard, the group designs software and testing solutions. This software has a major role to play in the validation, optimization, installation, and manufacturing of consumer products.
Manufacturers of computers, computer peripherals, consumer electronics, OEM products, medical equipment are the group’s primary customers. Given the broader breadth, this group typically sells more units and is less specialized than the communications group.
Lastly, we have Keysight’s Ixia solutions group that is responsible for $29 million in profits. This group focuses on testing the security of virtual networks and their associated components and applications. This means the group is involved in producing software to secure a company’s hardware, software and other services. The group’s primary income is derived from installation and warranty contracts.
It’s easy to forget that Keysight is still a growing company despite its size. A lot of its existing business stems from when the company was a division within HP, and the company has begun implementing its own sales channels effectively. The results of this have been phenomenal.
The last three quarters of 2019 witnessed huge growth and all quarters resulted in the company earning far in excess of analyst estimates. As a result, share prices have become a bit inflated but they still remain a bargain over the course of the long term.
As of this writing, 78 of the Fortune 100 companies are clients of Keysight. The business the company is going to source from them is only going to grow thanks to the ever-increasing demand on processor chips that the internet of things is going to require.
The upcoming decade is going to witness the birth of self-driving cars and increasingly smart devices. All of this will only accelerate demand, and Keysight is well-positioned to handle all of this. The research firm Gartner estimates that by 2022, the average American home will contain 22 smart devices.
The defense industry is also another sector that is going to witness increased demand for Keysight’s products. The massive human toll of warfare has led to a push to create robots that have greater involvement in combat, and these will need sophisticated technological inputs.
Overall, Keysight is in a great position to serve all of these increased demands.
Despite the firm’s focus on hardware, it is the Ixia solutions group where the most investment is taking place. This is because as time moves forward, implementing software as a solution (SaaS) revenue streams will become of primary importance. After all, hardware needs to be installed only once, but the software requires regular maintenance and upgrades.
At some point, Keysight will be called upon to maintain the hardware it installs, and this is why the shift in investment to SaaS is a good sign. The best part of this business model is the relatively high margins it generates. All of this is an excellent sign for the company moving forward.
The customer base of Keysight is varied, and the best part of this is that not a single company accounts for more than five percent of the overall business. This means that the company is not overly exposed to natural disasters such as the COVID-19 crisis. Evidence of this can be seen in the performance of the stock. Which has held up far better than its peers thus far.
This being said, some risks are present for Keysight. The highly technical nature of the business means that significant cash needs to be spent on R&D. As we mentioned earlier, America is behind China when it comes to the adoption and development of 5G technology.
The defense sector will especially place a huge demand on Keysight for these products, and if they don’t happen to be up to scratch, the prospect of losing a key customer looms. It also opens the door for an upstart competitor to enter the market. Despite this risk, the pedigree of management, as well as their track record, indicates that the company should be able to handle this well.
The recession that will most probably follow the viral outbreak should pose no threat to the company. It has a strong balance sheet and is secure in terms of cash and financing options. Continued investment into research and development is the key to growth and executives seem to understand this basic fact pretty well. The switch to SaaS and software- centric business models also indicate that they are on top of the changing economics of the industry.
Given the technologically sensitive nature of their business, Keysight has almost no Chinese exposure. It does source a few parts from that country, but all in all, the lockdowns have had no effect on Keysight’s business.
Competition from Chinese OEMs is what threatens Keysight’s domination in overseas markets where buyers are not as keen to buy American. The challenge here will be for the company to maintain its dominance in the face of an increasingly aggressive Chinese supply in the 5G and related technological space.
There are mitigating factors here, though. While the consumer-facing business lines will be impacted by the threat of Chinese products, the governmental business operations, and other high tech operations are unlikely to be affected for now. It remains to be seen how Chinese firms such as Huawei pivot from manufacturing low-level consumer-centric 5G goods to more complex hardware solutions.
For now, though, Keysight is ahead of its competitors and is a great investment. It has stable management that has a clear succession plan in place and has a history of stable earnings growth. Its customer base is extremely varied, and Keysight produces the one thing that all of them need no matter what. This ensures a steady demand.
All in all, the company is well poised to grow its profits well beyond the next decade.
Market cap – $210.38 billion
52 week high/low – 60.13/36.27
Coca-Cola needs no introduction. Everyone has heard of it, and everyone has drunk the beverage at some point in their lives. The company has been a financial giant of America with an increasing dividend for 57 years in a row. This makes it a dividend aristocrat with astonishing ease.
The company itself has always been viewed as a steady earner in times of distress and has always rewarded long term investors. Coca-Cola stock has never been an exciting headline grabber, but its real returns come from its steady dividend as well as the fact that it tends to outperform markets during downtrends, even if it lags during uptrends.
A huge seal of approval as far as the investment worthiness of the company is the fact that Coca-Cola remains one of Berkshire Hathaway’s largest holdings, with Cherry Coca-Cola being the chairman’s beverage of choice. This endorsement notwithstanding, Coca-Cola has been facing some headwinds in the past decade.
The world keeps changing, and consumer preferences change along with it. It began with firearms and tobacco companies being attacked in the mainstream and having vigorous campaigns mounted against them. We’re not here to judge the moral relevance of these campaigns but are merely tracing a trend factually. Advertising bans soon arrived, and these days, while tobacco companies are profitable and steady earners, they have lost the ability to grow explosively.
The same trend is catching on when it comes to the fast food and soft drinks sector. Companies that own their assets, such as McDonald’s, are good bets when it comes to the ability to thrive during such times. With soft drinks, the challenges are different. There are no real estate assets the company can own. After all, no one goes to a sit-down restaurant just to drink Coca-Cola.
Instead, the focus ought to be on reducing overhead expenses and diversifying away from a single product line. While health consciousness will reduce the demand for Coca-Cola over the upcoming years like never before, this doesn’t mean that the company has to sell bottles of Coca-Cola to remain profitable.
Coca-Cola has taken several steps in this regard, and these form the primary reason as to why it is a great investment.
Coca-Cola is one of the best-structured businesses on the planet. While people think of it as a soft drinks company, the fact is that in business terms, Coca-Cola is a beverage distributor. It has always separated its distribution business from its direct to consumer bottling business.
The company owned a number of bottling plants around the world and in the United States, but the revenues from bottling were separate from the revenues earned via syrup distribution. This decision was a far- sighted one and is paying off now. Given the headwinds Coca-Cola faces, it has begun divesting its bottling plants and is increasingly shifting towards becoming a syrup distributor.
This reduces overhead massively since bottling plants are factories that require massive capital investment and maintenance. A syrup distributor, on the other hand, has to simply manufacture the mix and sell it to the bottlers. The infrastructure required to make syrup is far smaller than what it takes to bottle the finished product.
For starters, bottles aren’t needed. The syrup is transferred in refrigerated trucks and is stored in plastic bags within cardboard boxes. All of this reduces overhead massively. Which indicates that Coca-Cola has read the signs and is restructuring its business to meet the challenge.
Its operating margin now stands at 29% as a result; this is unheard of for a company of its size.
Coca-Cola has long favored diversifying beyond its Coca-Cola syrup product offering. The company owns a number of brands around the world that have significant market share in their own right. Here is a list of brands the Coca-Cola owns:
Sprite (soft drink)
Fanta (soft drink)
Schweppes (soda water)
Appletiser (sparkling juice)
Dasani (mineral water)
Powerade (sports drink)
SmartWater (mineral water)
Vitaminwater (sports drink)
ZICO (sports drink)
Minute Maid (juice)
AdeS (assorted beverages) Costa Coffee (coffee chain) Georgia Coffee (coffee chain)
This isn’t the full list, but as you can see, there are a number of brands in here that are heavyweights in their own right. All of this means that Coca-Cola as a company, still has a lot of demand beyond sugary drinks.
Tagging a company of this size with the ‘growth’ label might seem ridiculous, but the fact is that Coca-Cola has a long way to grow at the moment. Brands within the Coca-Cola family such as Diet Coca-Cola, Coca-Cola Zero, and Coca-Cola Vanilla and so on have a smaller footprint than the primary product.
Investors often confuse the American market as being representative for the rest of the world, but this is not the case. Internationally, classic Coca- Cola is still the bestseller, but the company has only begun to market and push the other lines of Coca-Cola. For example, five years ago it was close to impossible to find Diet Coca-Cola in India, but now, the country consumes the drink in massive quantities.
Add to this the fact that there are other product lines that the company can push. For example, Dasani water isn’t widely available outside America at the moment, but the company is actively pushing the product, and there is massive potential for sales to increase.
When it comes to Coca-Cola it is impossible to ignore the sheer size of its moat. The name ‘Coca-Cola’ is widely recognized to the extent that it is used to talk about other types of products as well. Everyone and their grandma has consumed the product, and the color and font of the Coca- Cola script are widely recognized.
Then there’s the longevity that the company has displayed. It has been around forever and has weathered six recessions in the United States alone. It has expanded into countries that have come to associate Coca- Cola with America and stand as a symbol of refreshment and a lot more around the world.
It is fashionable to make statements that imply that a giant is about to fall but, to be honest, such statements tend to be false for the most part. It takes a lot of work for a mainstay of the American economy to fall apart, and as of now, this day seems very far away for Coca-Cola. As of this writing, there are less than five countries around the world where Coca- Cola isn’t the top selling soft drink.
As with everything, there are risks to investing in Coca-Cola. The company has been investing in creating further product lines and diversifying its product portfolio. It has expanded into snacks as well. All of this is a clear sign that it is witnessing a decrease in demand for the core product.
This might seem like bad news, it is, to a certain extent, but it can be mitigated with good diversification. It remains to be seen how well the management carries this out. It is a significant challenge the company faces. Replacing income that will be reduced from the Coca-Cola lines is a stiff task.
Due to these developments, the company’s balance sheet has become more leveraged. Currently, the debt to equity ratio stands at 0.71. Debt stands for the sum of all the loans and liabilities the company has. Equity is the capital it has in the form of shareholder value and represents the amount of a company shareholders own. This is despite divesting a large number of its bottling plants. In comparison, the debt to equity in 2010 stood at 0.1.
What’s more, Coca-Cola is increasing the level of debt it will carry by issuing bonds worth $5 billion with maturities ranging from 7, 10, 20, and 30 years respectively. This will increase the burden of interest expense it has to carry. Currently, interest expense is 2.7% of revenues, which is still manageable, given the fact that Coca-Cola doesn’t carry too many capital heavy assets.
The case for Coca-Cola mostly comes down to this: The expertise of management and their ability to diversify and evolve the core business. There is no denying that demand for the core Coca-Cola products will be lower 30 years from now. However, Coca-Cola has already diversified to such an extent that it isn’t solely dependent on the core drink line as it was 20 years ago.
As such, this means that the company has been anticipating a slowdown in demand for a long time. Which explains the re-structuring of the company to meet these changing conditions well in advance. Then there’s the fact that almost none of its product lines are likely to witness a drop in demand no matter how tough the economic outlook gets. Be it a recession or a boom, soft drink consumption will remain steady, and as the biggest bully in the space, Coca-Cola is unlikely to go anywhere but up.
Market cap – $40.41 billion
52 week high/low – 181.50/59.94
This company has become one of the coronavirus darlings and is one of the few companies that have benefited from the pandemic. If you weren’t acquainted with the software before, you sure are now. However, popularity alone doesn’t make for a great investment thesis. A good example of this are marijuana stocks that have been the rage since legalization. A large number of those stocks are now exploring new lows.
Zoom has long been a great investment. Since its IPO in 2019, where it debuted at $61 per share, the company has managed to grow despite a tough market. Tough in this context describes the conditions that were facing cloud computing companies. Many stocks in this sector saw selloffs of over 30%. However, Zoom managed to rise above its IPO price which was impressive.
The company has also been one of those rare Silicon Valley unicorns that managed to make money before going public. As of 2019, the company’s total revenue grew to $622.7 million, which represents an 88% increase from 2018.
However if you note the market cap number listed above, you will notice that the valuation of the company is ludicrously high, based on current numbers. There’s no denying that Zoom fits the qualities of a stock that you should ignore if you were to follow our previously listed principles. It is a media darling at the moment. Which means everyone is piling into it because they’ve heard the name, and have experienced the platform to an increasing degree thanks to the pandemic.
This has led to Zoom selling at a ridiculous 50x multiple to sales and an even more ridiculous valuation when it comes to the earnings ratio. A lot of sensible investors will be scared away by these multiples and they would be justified in doing so. So, why are we recommending Zoom as an investment?
For starters, there’s the product itself. The software was popular even before the pandemic thanks to its sleek interface and ease of use. Now that active users have grown to 12.92 million on a monthly basis, the software is all set to become even more popular. A large part of Zoom’s rapid growth in its user base has to do with its product-market fit.
Tech analysts often use this term to describe the ‘X factor’ that a particular stock or company has. They use this to explain why a product achieves virality. As such, no one knows what this really means, and it’s one of those terms that are a catch-all for inexplicable behavior. Much like how market selloff in the 90s and in the previous decade was due to Arabs selling stuff, “product market fit” is a catch-all term for viral phenomena.
One of the key reasons for Zoom’s growth that we can easily discern is that it does not need any account-based dependency across platforms. This means you could be working on MS Outlook and still use it. Other collaboration software such as Skype and Google Hangouts are either clunky or require authentication from multiple accounts before logging in.
This played a key role in the early adoption of Zoom. Most importantly, growth was driven from the ground up. Meaning, it wasn’t imposed on workers by management. Instead, it was lower-level employees who insisted that management use the software. All of this bodes well for long term user retention. With telecommuting on the rise and set to become the norm over the next decade, Zoom is right where it wants to be.
As we mentioned earlier, the earnings multiples on Zoom stocks are nonsensical. The company is selling close to 260X projected earnings, which is extremely high even for a darling tech stock. Compare this with a multiple of 130X for Shopify and Slack, and you’ll see how overvalued Zoom currently is.
Despite this, Zoom has excellent long term growth prospects. The market size of communications as a service has been estimated to be $43 billion (Mckenna, 2020). Zoom’s position as a leader in this space and its current valuation means that there is a long way to go.
What’s more, Zoom is in the process of releasing a new feature called Zoom Phone which is VoIP calling without the need for video. As of current writing, 16% of the total workforce in the United States telecommutes. This was before the virus hit, and it doesn’t include American workers traveling overseas or the large gig economy that exists in the form of freelancers and consultants.
All of these numbers are set not just to increase, but explode. What’s more, this doesn’t take into account the international market where Zoom has witnessed huge growth. From 2018-2020, Zoom sourced 17- 20% of its total revenues from EMEA regions as well as Asia-Pacific countries.
Another great quality that Zoom has consistently displayed is its ability to convert free users into paid customers. A lot of SaaS companies rely on the Freemium model of business. The Freemium model means they offer basic features on a free basis but more advanced features for a fee. A high conversion rate indicates that the premium features add significant value, and this is a great sign for sustainable growth. Many SaaS companies fall victim to free users driving up operating costs, and not being able to offset set that with the required number of paid users. Zoom does not have these issues.
Despite all of the positives that we’ve highlighted, the fact remains that Zoom is still an extremely young company, and there are many risks it faces. Despite the growth in users during this time, it still faces the challenge of having to retain those users. Tech apps are extremely prone to having their users flee to some other platform at the drop of a hat.
Remember when Skype was all the rage? It existed back when apps were still called programs! You would reason that backing from a huge company such as Microsoft would do it a world of good, but this hasn’t really been the case. The software is often mentioned as an also-ran at this point.
Zoom is susceptible to these risks as well, so user growth alone won’t cut it. The primary feature that drew people to the app was the ease of use and the ability to work across platforms. While the consumer usage is what is making headlines of late, it is the business usage that drives the business. How Zoom handles the surge of users remains to be seen.
As of now, the signs are promising. Zoom recently made news when it was sued by a developer out in California, claiming that the company had shared his data without his consent. Soon, news websites were flooded with headlines stating that Zoom was unreliable and that it wasn’t end-to-end encrypted. A lot of this was hysteria, so it’s worth delving deeper into this and understanding what really happened.
First, let’s deal with the case that brought all of this to light. The developer’s claim was primarily that the company had shared his data without proper notice. Zoom responded in a blog post by saying that the issue had occurred due to them installing a Facebook software development kit, which allowed users to login using their Facebook Id.
As a result, Facebook collected information about the users logging in and stored it on its platform. As such, it was Facebook that was at fault, and Zoom’s mistake was not to know that this was possible, which is sloppy. However, the company owned up to this mistake in a blog post and stated the following (Yuan, 2020):
‘We originally implemented the “Login with Facebook” feature using the Facebook SDK for iOS (Software Development Kit) in order to provide our users with another convenient way to access our platform. However, we were made aware on Wednesday, March 25, 2020, that the Facebook SDK was collecting device information unnecessary for us to provide our services. The information collected by the Facebook SDK did not include information and activities related to meetings such as attendees, names, notes, etc., but rather included information about devices such as the mobile OS type and version, the device time zone, device OS, device model and carrier, screen size, processor cores, and disk space’
Following this, further investigations were conducted, and this is when the lack of end to end encryption came to light. Initial reporting suggested that Zoom had marketed their software as having this level of encryption, but it looked like they had lied. This is untrue.
The issue lay with the way the encryption keys were being stored. The data itself is fully encrypted, and it is impossible for Zoom or anyone else to access. However, the keys that unlock the data were being stored by Zoom in its own cloud. The reason it was doing so was this: Zoom was originally designed for business use.
Business users typically place additional security measures across their networks prior to logging in and this ensures that encryption keys are stored on their own servers. The sudden rise in consumer usage meant that Zoom had to begin storing keys on its own cloud since there was nowhere else for them to store it. The sudden and massive rise in user numbers is what caused the issue, and there wasn’t malice on the company’s part.
The CEO of Zoom, Eric Yuan described it in a blog post. He stated that the product was designed to be used by large corporate users who carry out their own separate security checks on their networks. As a result, Zoom didn’t need to carry a lot of protocols that are required for daily consumer use.
The rapid and unprecedented growth of the user base didn’t leave the company with enough time to build these features, and as a result, Zoom was caught off guard.
All in all, the company had issues and dealt with everything in a transparent manner and didn’t lie to its users or cover up its efforts, like how Facebook and Google have done in the past. This is a sign of competent management that understands the current climate surrounding data privacy and takes it seriously.
As far as management indicators go, these are pretty strong ones. This didn’t stop the negative headlines from rolling in. Media darling Elon Musk banned Zoom usage across Tesla while in what was effectively a candid admission of an inferior product, direct rival Google banned the usage of Zoom as well. The implication here is that Google’s own employees preferred Zoom to Hangouts.
All in all, Zoom is not without risk, but the ability of management to weather this crisis and display transparency is something that bodes well for its future. We would like to see Zoom trade at lower prices, and you’ll learn why after using our company valuation tool in the next module.
Market cap – $11.25 billion
52 week high/low – 176.40/48.57
With everything becoming digital these days, it stands to reason that healthcare would follow in these footsteps as well. The global telehealth market is projected to reach a size of $55.6 billion by 2025, and Teladoc is at the forefront of this revolution. In-person visitation has lagged behind the rest of the healthcare segment thus far in terms of digital applications.
After all, it is tough to diagnose someone without seeing them in person. The outbreak of COVID-19 has changed this space completely. With increased risks associated with in-person contact, video conferencing ability, and e-consultations are on the rise. While you might be tempted to think that this is just a virus related fad, the numbers say otherwise.
Teladoc has witnessed huge growth over the past decade. In fact, in the field of telehealth services the company is far ahead of giants of the space such as Humana and UnitedHealth Group. It also happens to be the only telehealth service provider that trades publicly, which puts it far ahead of its competition.
Furthermore, the viral outbreak had opened people’s eyes as to how effective virtual doctor visits can be. An initial analysis suggests that this behavior will continue in the future as people become more secure with this form of doctor consultation. Overall, telehealth and telemedicine is a “mega trend” that is bound to become even more popular over the coming decades, and Teladoc is right at the forefront of it.
The company currently covers treatment for a variety of medical issues. As of 2019, Teladoc provides virtual consultation services for over 450 medical subspecialties. These also cover mental health services through its subsidiary BetterHelp.
Within the United States, the company has over 36.7 million unique users (up 61% YoY) who are paid members and 19.3 million users (up 104% YoY) who pay one-time visit fees on the platform. Thanks to the acquisition of Advance Medical Healthcare Management Services, the company now provides services in 130 countries and in 30 languages 24 hours a day.
Acquisitions are the primary mode of growth for Teladoc. In addition to patient-facing services, the company also invests in developing enterprise platforms for hospitals and physicians to bring them on board its network. Nine out of 10 insurance providers are supported on the platform, and this has ensured broad appeal.
Teladoc currently provides B2B healthcare solutions to over 12,000 businesses across America, with 40% of these businesses being Fortune 500 companies. The company has also partnered with CVS pharmacy to position itself as the virtual healthcare service provider of choice. In addition to this, Teladoc works with 50 major American health insurers and over 70 international health insurers and finance firms.
The CVS partnership, titled MinuteClinic expanded from 18 to 26 states last year. The revenue model is pretty simple. Clients pay a monthly subscription fee, and there are no hidden fees within this.
The real driver of growth in the B2B segment has been the adoption of multiple services by clients already on the platform. Teladoc states that 40% of existing clients subscribe to two or more services within its network with BetterHelp witnessing the largest growth.
A significant advantage that Teladoc has is that it can collect usage data and analytics about the users and physicians on its platform. The company has strict data protection policies, so patients do not need to worry about medical histories being leaked. The analytics that the company collects are primarily designed to develop better engagement with existing users as well as to drive growth by signing up new users.
These analytics are what fuel the company’s marketing strategy, and thus far, all campaigns have been a success with new user signups increasing at a record pace. The company’s platform itself has been designed, so that introduction of new services is seamless.
This happens due to deep investment in infrastructure that allows Teladoc not only to provide a robust platform but also allows for real- time eligibility checking and integration with insurance companies.
There are many roadblocks that telehealth companies need to navigate as of this writing. First off, many of the treatments for complex or severe conditions cannot be prescribed without an in-person visit. This is understandable and is something that telehealth providers will not overcome anytime soon.
A bigger hurdle that can be overcome is the ability of doctors to prescribe treatments virtually. To this effect, Teladoc has partnered with Thomas Jefferson University to offer a fellowship aimed at training doctors in virtual care. The company has also teamed up with the University of Southern California to research antibiotic prescription in virtual healthcare.
These efforts prove that Teladoc takes its commitment to its business seriously. They have been in business for over 10 years and have been steadily expanding in a growing industry. While it has been gaining attention thanks to the COVID-19 outbreak, the company is more than just a short term fad.
There is a lot going to Teladoc. It is a relatively mature company operating in a fast-growing field. It has ample cash reserves and doesn’t have many competitors in sight. The fact that it is far ahead of the curve of its much bigger rivals in the space means that if its upward curve continues, it should be a prime takeover candidate which will ensure investors receive some pretty sizable gains.
Market cap – $25.94 billion
52 week high/low – 266.20/128.85
Another trend that has been growing is holistic fitness. While the previous decade saw the expansion of gyms and fitness clubs, this decade has seen the growth of fitness routines such as calisthenics and yoga.
The thing with such routines is that they’re a lifestyle as well as a training regimen. They inspire extreme loyalty amongst those who practice them, and this royalty extends to any brands that serve this space. One of the biggest companies that inspire such cult-like loyalty is Lululemon Athletica.
From the outside looking in, Lululemon sells a bunch of overpriced clothes along with mats and other accessories that seem to make no sense. For instance, one of its products happens to be a yoga mat that is priced at $88 and headbands for women that are priced at $40. These prices don’t make much sense to the outsider, but to someone who lives the lifestyle, they’re perfectly fine. It’s the same phenomenon as with Starbucks’ prices. Lululemon Inspires extremely high levels of loyalty, and purchasing its products is a bit like buying your way into a club of fellow lifestyle seekers.
The majority of the brand’s customers are women. Which makes sense since, in North America, the majority of yoga and alternative fitness practitioners happen to be women. Lululemon’s apparel and accessories are hot sellers but they also stand up to scrutiny in terms of quality. Unlike apparel from other fitness brands, the clothes are not produced in sweatshops in third world countries, and this is often something that appeals to shoppers.
Scarcity and Growth
One of the things that Lululemon has going for it is the fact that for a brand that inspires so much loyalty, the number of physical outlets it has is laughably low. The brand had just 38 physical stores around the world till the end of 2018 and by the end of 2019, had opened an additional 51 stores.
Obviously, in hindsight, this seems like a bad investment, and no doubt it will hurt during the short term. Given that yoga studios and fitness centers of all kinds have closed, the brand is likely to witness a few tough quarters this year. However, a lot depends on when isolation protocols will ease. If we witness restrictions ease before the holiday season this year, sales could increase and power profits.
However, all of that is conjecture. As of now, we can conclude that the low number of physical outlets contributes to creating low overhead costs as well as creates a scarcity effect. The fact that its stores are located mostly in trendy cities only adds to its allure. All in all, Lululemon does a great job of marketing its lifestyle-based message instead of pushing itself as just an apparel manufacturer.
This allows it to differentiate itself from the other giants in the space such as Nike, Adidas, and Puma.
The company is based out of Canada but counts the United States as its biggest market. Over 90% of its customers are based in the US. A good way to think of its appeal is to liken it to Starbucks. It is a place that offers luxury at affordable prices, even if it isn’t the cheapest.
Its customers recognize all of this and see it as an indispensable part of their lifestyle. Then there’s the fact the company was perhaps the first fitness apparel maker that dedicated itself to creating clothes for women. The founder of Lululemon, Chip Wilson, (we’ll deal with him in more detail shortly) mentions the practice of ‘shrink it and pink it’ that was relevant in the fitness apparel industry at the time (Lieber, 2018)
This refers to shrinking the size of men’s fitness apparel and coloring it pink, thereby creating women’s apparel. Women noticed this needless to say and had to resort to wearing dance leggings that were simply not made for exercise routines such as Yoga. Wilson’s solutions to redesign apparel created a splash, and this is what helped develop the cult-like obsession that its customers have.
There is a roaring second market for used Lululemon clothing. Luxury brands such as Chanel and Gucci often witness huge interest in used goods of theirs but Lululemon is the only athletic apparel manufacturer that draws such interest. Scarcity is at the heart of this once again. It begins with the way each style is introduced into the market.
Garments are given names that signify their uniqueness as well as their color. Next, the company gives purchasers just 14 days to return goods they’re unhappy with. This is a far stricter return policy than what most retailers practice, and it does leave them with unhappy customers. However, it creates supply for the secondary market.
Lastly, Lululemon produces fixed quantities of its styles and never replenishes stocks. This means that if you own a pair of leggings, you’re one of the few people in the world that do. The scarcity model is even enforced geographically. Styles that are released in say, Tokyo, are not released in New York.
This has led to blogs and communities being set up that follow Lululemon’s style releases with a fervor that is usually reserved for fashion week luxury brands. Lululemon is well aware of these practices and has gone so far as to deny service to suspected resellers. During certain periods, it bars people from buying more than a certain number of items of clothing to stop them from reselling it at a higher markup (Lieber, 2015).
Events the company holds, such as the Sea Breeze Half Marathon, tend to witness huge sales of items that immediately pop up on eBay and other reseller sites. While the company discourages these practices, from an investor’s perspective, all of this screams economic moat.
Lululemon has long since recognized its brand power and has invested in a tech startup named Mirror. This company aims to develop smart mirrors that can be used to provide fitness instruction along with further recommendations. It’s not hard to see how this could help Lululemon expand its product offerings.
While its retail outlets are small in number, Lululemon’s website is a huge driver of sales, as are its special events that are regular fan fests. While physical stores will naturally be closed right now, the high level of loyalty, the brand inspires will only boost online sales and will help it diversify its revenue streams well into the future.
This is going to be perhaps the most soap-operatic portion of this book. While the founder of Lululemon, Chip Wilson, is rightly credited as being one of the retail industry’s visionaries. The company he created refuses even to acknowledge him on their ‘about us’ page. A major reason for this is the drama that Wilson created while he was in charge of the company.
Never one to hold back on his views, he said he created Lululemon primarily to help women “make their butts look better” and one of his self-confessed metrics for this was the number of compliments men would give women without realizing exactly why the woman’s butt looked better than before (Lieber, 2018).
One of his more famous policies was to hire employees who were family- oriented and wanted to have children in the future. He even went as far as to dub kids as being “nature’s orgasm.” None of this pleased shareholders, but there’s no denying it did create an aura of rebellion around the company and helped it achieve a cult-like following.
Speaking of cults, Wilson is also credited with developing the self-help employee training program that all recruits go through when they join the company. The details are far too bizarre to recount here, and you can refer to the sources at the end of this book for a full account.
Despite all of his faults, Wilson also ended up designing perhaps what is one of the best protocols for on-floor sales techniques. Lululemon’s salespeople are instructed to adhere to a very specific sales manner. If the customer stares at a product for six seconds (yes, it’s timed), the salesperson (called an “educator”) has to deliver an enthusiastic speech about how wonderful the product is. At this point, if the customer doesn’t have further questions, the salesperson walks away.
They return when the customer stares at another product for six seconds and the same routine begins all over again. This sounds strange, to say the least, but it has resulted in Lululemon achieving per square foot sales numbers on par with Tiffany’s and Apple, both of whom sell vastly more expensive products.
Wilson is long gone from the company, having been ousted acrimoniously in 2013, and the management that is in place now is far better suited to run a large public corporation. While Wilson was best suited for the company’s buccaneering days, Lululemon is a giant now and isn’t really an underdog. As such, his presence would only destabilize the brand’s position.
It isn’t all just cults and spandex when it comes to Lululemon. The company has an astonishing $1 billion in cash and has close to zero debt. This is pretty remarkable for a retailer that has just opened 51 new stores. As a result, the management does not foresee the need to have to borrow money via debt offerings or equity financing.
What’s more, the company has been buying back its stock throughout 2019 and will probably continue to do so, provided sales don’t fall off a cliff completely in 2020. Despite the headwinds facing the company and the female-centric sales material, men’s apparel saw a jump of 34% along with the operating margin increasing as well. Based on current numbers, projected growth and unique marketplace positioning, the company is in a good financial position to deal with the current crisis and is well set for the future.
Market cap – $34.02 billion
52 week high/low – 186.22/82.00
As we’ve already outlined before, China has made the leap over the past decade from a growing economy to emerge as a truly dominant world power. The country seems to be shedding the last few characteristics of a ‘growing economy’ and is now a fully grown one, even if the immediate effects of this are not being felt.
One of the major reasons for this is the nature of the government, and the way it controls the spread of information. Transparency is extremely low in China, and investors are wary, correctly so, of investing in any Chinese company. While the likes of Alibaba prove that fully private enterprises can flourish, the fact is that it is far easier to grow in China when you have strong government ties.
Political leanings aside, this means that any investment in China is better off if it is done in a company that has good ties to the government and is in a critical area of growth. Chinese government is focusing its efforts on developing its technology. The country is seeking to move away from its image as a manufacturer of cheap toys and goods. Instead moving into the high tech space.
The rise of Huawei, a firm that was founded by a former high ranking Chinese soldier, in the 5G space is proof of this. All tech stocks receive patronage from the government, and Baidu is one of the beneficiaries of this. The company is virtually unheard of outside of China but within the country and in parts of SE Asia, it trounces Google completely.
Baidu is one of the largest search engines on the planet thanks to the volume of its users. Google is officially banned in China thanks to censorship issues, and this gives Baidu a near monopoly over the Chinese internet. As of current writing, the platform has over 700 million users. The staggering aspect is that this number represents just half of the Chinese population.
With internet coverage set to grow in China and with the government effectively favoring Baidu’s monopoly over the internet and flow of information, the company is almost certainly going to witness an increase in the number of users over the next few decades.
The business is a replica of Google, and as such Baidu’s revenue model is the same. It relies on pay per click (PPC) advertising, and as the largest ad platform in China, its earnings have been rising steadily over the past decade. Recently, PPC revenue dropped thanks to increasing controls of ad standards, but once the dust settles and as advertisers adjust to the new standards, revenues should be back where they were.
Like Google, Baidu has long since moved away from its search engine roots and has become a full-fledged tech company. It is the only company in the world that has received a license to operate self-driving vehicles and currently operates a bus successfully within its campus.
It has also invested heavily in driverless cars, and over the next decade, these are expected to rollout. News is predictably bullish as it is with every Chinese news source, but there are signs that these news items are genuine. While these lines of business are not profitable or even collecting revenue at the moment, they do hold huge promise for the future.
In addition to the vehicles themselves, Baidu has also developed an open-source software named Apollo that can be used to program driverless cars. The business model here is the same as what Google did with the Android phone operating system, and the hope is that as more companies enter the space, Baidu can become the software provider of choice instead of getting into costly hardware investments.
As Google has YouTube, so does Baidu have iQiyi. Here, Baidu faces some pretty stiff competition. The first competitor is Tencent video, which is backed by the giant Tencent, and the second is Youku Tudou, which is owned by Alibaba. These three companies are present in the same space and engage in one form of state-sanctioned competition or another.
It appears that for now, Baidu is not favored in this race with Alibaba leading the way. One reason for this is that its platform is actually an amalgam of two earlier video platforms that were developed late in the previous decade. As a result, the company received an early boost in terms of the user base. However, Baidu’s dominance of the search engine world does mean that it can compete with these other platforms even if it cannot dominate.
Ad revenue from the video-sharing platform is lower than PPC ads in search. This has as much to do with Baidu’s lack of penetration as it has to do with how unsuitable video platforms are for the PPC model. After all, even YouTube barely makes any money and its ads aren’t the most efficient.
iQiyi is much more than just a YouTube clone though. In fact, all of the Chinese video platforms can be seen as a combination of Netflix and YouTube. iQiyi is often dubbed the Netflix of China but this is simply because it’s an easy way to explain what the platform is all about. It’s a bit more than that as we’ve just described. It is also an online gaming platform that is a bit like Steam and Twitch where players can subscribe to play games as well as share their in game heroics across the network.
One of the fields that Baidu is spending a lot of money on is AI. Chinese firms have a massive head start on the rest of the world in terms of AI thanks to the surveillance that the government engages in. This gives them access to far more data than is available in other societies. Moral quandaries aside, Baidu is no different in this respect.
It has developed a voice assistant (think Alexa) called DuerOS which seamlessly works on smartphones and other smart devices. It is witnessing huge growth. While the company isn’t clear on the user growth, one way of measuring this is via the growth in users of the app. This number grew by 21% over 2019 with previous years recording growth as well.
In addition to this, the number of voice queries on DuerOS grew fivefold to 4.2 billion queries per month. Currently, DuerOS is available on Baidu produced Xiaodu devices which span from speakers to smart displays. In the B2B space, Baidu has an AWS clone in Baidu Cloud which offers server space and IT infrastructure services to enterprises.
The company has a few diversified revenue streams but is still heavily reliant on the effectiveness of its PPC ads. In this regard, it is similar to Google, but like Google, the plan is to ramp up earnings from other areas of the business as technology continues to mature.
A major knock against Baidu is that its stock performance has been abysmal over 2019 and this was before the virus hit. However, this is just a reflection of the emotion driven selloff that afflicted its sector.
A big reason for the terrible performance was that all Chinese tech stocks were overvalued to begin with. The increasing growth and prominence of China as a technological hub prompted many investors to move into Chinese companies and tech were recipients of this money.
As a result, valuation levels grew to absurd levels. Consider that the stock is now selling at a 14x earnings multiple. For comparison’s sake, Google is selling at 24x. This shows how grossly undervalued Baidu currently is and how the impact of the virus has been mispriced.
While it is true that a recession will impact Baidu’s earnings, just how bad will the impact be on its core business? With physical stores shutting down, businesses will be forced to turn online. This leaves Baidu as the only viable outlet for advertising, and it already dominates 80% of the sector.
Thus, the domination is likely going to be extended moving forward. Over the short term, the company is addressing its cash needs by issuing debt to the tune of $1 billion in short term notes. This should see it tide over any recession concerns.
The Chinese government has been moving swiftly to contain the impact of the virus within the country. All of this means that the Chinese economy is likely to bounce back faster than the rest of the world, and as a result, Baidu’s prospects will behave the same way. All in all, Baidu might be a bit more opaque than other Western companies, but this doesn’t mean that it is incapable of growing its earnings.
The economics of its industry look good. Additionally, the political importance of the company in terms of information flow, Baidu is well set for the future.
Market cap – $1.09 billion
52 week high/low – 23.04/6.21
Zuora (pronounced zoo-aura) is yet another stock that has taken a pounding over the past year. On the surface, all news surrounding this company is bad. It hasn’t been able to turn a profit as yet, despite going public in 2018 and being founded back in 2007. Its business is in the B2B space which means that a lot of information surrounding it is loaded with technical jargon that is all but incomprehensible to the average investor.
The company was initially founded by two engineers K.V Rao and Cheng Zhou, who worked at WebEx at the time. Rao is the one who had the idea to build a platform that could handle SaaS billing models. These days, the SaaS billing system is everywhere, and from a consumer’s perspective, it’s pretty easy to handle.
You simply click a button that says subscribe and pay a monthly fee for the software service. However, from a technical standpoint, SaaS is a headache of gargantuan proportions. In 2007, most companies relied on billing their customers once for the product and delivering it. SaaS posed technical challenges to the very architecture of their databases.
Think of it like this: You’ve built a large mansion only to find that instead of building a single large house, there is greater demand for a number of smaller apartments. You can either tear down the mansion or modify the place to create some sort of a complex, but this isn’t going to really do the trick.
Even if you do tear down the place and look to build smaller apartments on the land, who’s going to design it for you? Remember that in this analogy, no one has ever built apartments (SaaS databases) before. Therefore, companies were forced to modify their existing databases, and this led to a number of things breaking.
This is what prompted Rao to brainstorm a solution along with Zhou, and they arrived at an initial solution. However, they lacked marketing skills and, as a result, could not convince venture capitalists to back them. This is where the current CEO Tien Tzuo came into the picture.
Tzuo was a big believer in the efficacy of subscription-based models, and as a senior executive at Salesforce, he was well aware of the challenges. Tzuo polished the original ideas and his contacts in the industry managed to land the funding needed, and thus Zuora was born.
While the original founders have since exited amicably, Tzuo continues to function as the chairman and CEO. He’s seen as an evangelist for the subscription business model, and has even written a bestselling book on the topic. Zuora currently develops and manages custom solutions to handle subscription payments for their clients.
The problem is that, much like with the evangelist of electric cars, Tzuo’s company doesn’t make any money. Over the past year, Zuora’s stock has dropped by 51%, which is a pretty epic fall for a company so many people expected great things from. So, what’s really happening here, and why is Zuora still a great investment?
There’s no denying that the subscription-based payment model is here to stay. Zuora happens to be suffering from the pioneer syndrome we previously mentioned. Being the first to the space, the company has had to deal with problems and unforeseeable circumstances every step of the way .
The fact that company revenues have grown every year despite these challenges is a testament to Tzuo’s leadership and the ability of senior management to handle tough times. Zuora is a tough company to analyze because it’s still effectively in a startup stage despite being a public company. Typically, companies with Zuora’s financials don’t go public but the lengthy bull market meant the Zuora went public a bit ahead of the curve.
This means that the best way to look at the financial of the company is by looking at its revenue and user growth. Profits might not be present right now, but with continued growth, Zuora stands to capture a significant portion of the market.
The simple reason for such optimism is that there is no other company of its size that poses a threat. Zuora moved first and moved fast in this space, and this gives it a clear head start in terms of technology as well as know-how. Low employee turnover has also meant that the company has done a good job of retaining its knowledge.
This experience is reflected in the diversity of its product lines. The original product that Zuora developed was Zuora billing. This is a turnkey solution for companies and large enterprises to easily migrate their existing one-time payment systems to a subscription-based model.
The other product Zuora integrates with its primary platform is Zuora RevPro which handles all of the accounting needs for subscription-based businesses. Accounting poses a particular headache when it comes to SaaS since GAAP rules specify certain methods in which regular payments need to be booked. It isn’t as simple as recording the monthly payments that flow in. GAAP refers to Generally Accepted Accounting Principles that all American firms follow. These are guidelines that define how cash flow is meant to be accounted for on a company’s books.
The appeal of RevPro goes beyond just tech-based enterprises. With the way payment methods are changing, the model is extending to pretty much every industry out there. A good example of this is Dollar Shave Club, which operates this model when it comes to men’s shaving products.
Some of Zuora’s other customers include Harley Davidson and Caterpillar. The revenue model is also quite straightforward. Zuora charges a flat fee plus a monthly volume-based fee. The fees are quite cheap and are far more economical for companies to adopt as opposed to designing their own solution.
All of this puts the spotlight squarely back on customer growth. Instead of charging four customers a quarter each to make a dollar, Zuora aims to charge 100 customers 100 pennies to make a dollar. One of the problems with Zuora’s stock is that analysts aren’t sure how to set expectations, which reveals one of the problems of an emotion-based market.
The company is being valued at its current level because it isn’t meeting expectations. These expectations vary wildly, and as a result, the stock witnessed a lot of volatility. Its revenues grew by 15% the previous year, but despite this, the stock tanked 51%. The sole reason is that revenues didn’t grow fast enough, not because there’s anything wrong with the company .
It’s a bit like receiving $100 and complaining that you didn’t receive $1,000 when there was no indication that a payment of $1,000 was possible. These emotional corrections will smooth out over time as Zuora continues to grow. Growth is almost guaranteed thanks to the state of the subscription-based billing model. Meaning that Zuora is a solid long term play.
Market cap – $57.74 billion
52 week high/low – 619.00/350.00
Intuitive Surgical sits at the intersection of technology and medicine. Specifically, as the company’s name suggests, it is focused on the field of robotic surgery. This field is a crowded one, and it is rife with competition despite the highly technical and specialized nature of the product.
The appeal of robotic surgery is easy to understand. A robotic arm cannot tire or make involuntary mistakes. Despite the term robotic in the name of the process, this doesn’t mean that a robot is the one performing surgery. Instead, it is guided by a human being at all times. It’s just that the process removes the possibility of involuntary human error.
The demand for robotic surgery first came from the military, which needed emergency medical procedures carried out on soldiers wounded in war zones. In such places, flying a specialist surgeon out would have put them at risk, and this is how Intuitive Surgical first began life.
It has been around for over 20 years now and continues to make money from defense contracts. Its patented DaVinci surgical system is one of the best in the industry. Intuitive is one of the pioneers that came through the tough times in this industry. Now that it’s emerged as one of the leaders of a maturing space, it finds itself the target of competition.
This comes in the form of medical giants Medtronic and Stryker deciding to expand their robotic surgery business. Along with this, Johnson and Johnson have announced a partnership with Google to develop and run a wide variety of robotic surgery solutions in the market. All of these companies are far bigger, and it remains to be seen how Intuitive copes with this competition.
Despite all of this, the company has a well-established moat. Intuitive has network effects giving it a wide level of acceptance amongst surgeons. The DaVinci system is simple to use, by surgical standards, and its precision level is unmatched. The system made waves when Intuitive advertised it by performing surgery on a grape to demonstrate how precise the technology is.
The industry itself is witnessing huge growth, which explains why the giants of the sphere are looking at moving in. Studies indicate that patients who experienced surgery with the DaVinci system experienced lesser complications than those who opted for conventional methods.
In addition to this, regulatory approval for surgical robotics has been increasing, and unlike other fast-growing industries such as marijuana and sports betting, there are no hurdles in this regard. People will always need surgery, and as time progresses, robotics are certain to be embraced as acceptable solutions for this. This doesn’t mean there are a few issues with Intuitive.
One of the downsides of being valued as a tech stock is that a large degree of expectations of growth are factored into the price. This has been true of Intuitive during this decade. As their technology grew and as tech gained widespread exposure, the valuation of Intuitive rose in line with that of other tech companies.
This meant that the stock has been overvalued for a while now. It took an almighty tumble at the beginning of the year before bouncing back up. In this, it is hardly unique and many stocks have witnessed similar behavior. This means that for the first time in many years, Intuitive stock is priced according to its proper value.
This represents a great buying opportunity for investors. One of the reasons the stock went as high as it did was due to the fact that the DaVinci system has been increasingly adopted and as of this writing, the firm declared profits of $1.4 billion on $4.5 billion in sales.
This amount is more than enough to cover its entire cost of production and operating costs. For a company of its size, this is a truly remarkable achievement. The good news is that this number is only expected to increase over time. Over the past two years, net income has increased by 105%.
Of course, Intuitive needs to redirect a significant amount of money into research and development, and this will pose challenges. Typically, R&D efforts take time to bear fruit, and a wrong decision here can set the company back. However, it isn’t as if Intuitive is the only company in this field that is running these risks.
All in all, its fortress-like balance sheet and existing moat make it an attractive investment for the long term.
Market cap – $124.3 billion
52 week high/low – 124.45/82.07
We’ve mentioned Elon Musk a few times, and we’re now going to highlight his earliest success. PayPal was created by combining Musk’s venture X.com with co-founders Peter Thiel, Max Levchin and Luke Nosek’s company Cofinity. The company X.com was renamed PayPal and went from strength to strength in the late 90s.
Shortly after its IPO, PayPal became a subsidiary of eBay. A remarkable fact about PayPal is that almost every single one of its original employees went on to found or become early investors in pretty much every Silicon Valley heavyweight we hear about these days. In no particular order, companies such as Tesla, SpaceX, Facebook, Sequoia Capital, Flickr, Digg, LinkedIn, YouTube, Yelp and Reddit all trace their roots back to the original employees of PayPal.
All of this has given PayPal an even bigger reputational moat as the years go by. People want to work for the company thanks to the cult of personality that its founders have developed. The company continues to become even more bureaucratic in terms of the way it treats its customers and yet, the sheer weight of its brand name makes it pretty much the only payment processor of choice for a large majority of people.
PayPal is one of those rare companies that has had two IPOs. It was first bought by eBay after its first IPO in 2001, and in 2015, once it became clear that PayPal was eclipsing eBay in terms of sales and profits, the parent company decided to spin it off. Since being detached from eBay, the company has seen remarkable growth.
One of the reasons for PayPal’s growth and continued success is the smart acquisition strategy that the company has followed over the years. Let’s take a deeper look at why PayPal is such a great investment.
The digital payments space is set to witness an explosion in activity thanks to the growing unpopularity of cash as a mode of payment. With increasing levels of digitization, governments are finding that extending this to cash and banking transactions helps them recover a greater amount of tax revenues that would have been lost otherwise.
The founding of cryptocurrencies is just the beginning. While cryptocurrencies have not been fully accepted and their exchange is still barred or full of hurdles in many places, governments have taken the hint and have effectively tried to turn their own currencies digital.
Scandinavian countries were some of the first to adopt this tactic. These days a cash payment in those countries attracts an additional cash handling charge at checkout counters. The norm is to usually charge a commission on credit card payments, but here it is reversed. Similar practices are followed in the Netherlands and parts of Western Europe.
The nature of the working economy is also playing a part in this. Clients and suppliers now exist across borders more than ever, and using tired old SWIFT or IBAN bank transfers is a thing of the past. These attract higher levels of fees and also require you to input and set up beneficiaries in your own bank’s system. Even after all of this, there is the prospect of the money being routed to the incorrect account.
All of these hindrances have left the payments space wide open for digital solutions to rush into. Banks have responded to this threat by doing nothing and have instead leaned back on their primary cash cow of lending to generate profits. This means that the number of restrictions on digital payments grows less day by day, and cash as a means of transaction will soon be a thing of the past.
PayPal is the founder of digital payments, and as a result, everyone associates the company with this activity. Small businesses prefer to use PayPal since it’s an easy way to receive money without involving tedious bank transfers. Retailers, in general, understand that accepting PayPal is better than not accepting it.
The moat surrounding PayPal is so strong that merchants are willing to accept payments on it despite having to pay high fees. There simply is no other solution at the moment. This is especially true when it comes to the online space. Websites that accept money of any kind integrate PayPal into their structure since users find it best to pay this way.
As we mentioned earlier, the lack of options in the online payment space is partly because of the acquisitions that PayPal has carried out. One of the best acquisitions PayPal has carried out is with Venmo. Venmo dominates the space of peer to peer payments and is preferred far more than bank transfers.
The app currently has over 40 million accounts and, in the fourth quarter of 2019 handled $29 billion worth of transactions, which comfortably puts it in the lead in p2p payments. This also represents a growth of 56% when compared to the previous year.
While Venmo is used primarily for in-country transactions, Xoom is the platform of choice for cross border transactions. The service is used for far more than money transfers and cash pickups. Xoom also allows its users to recharge mobile phones’ balances. Xoom is focused on the phone payments space and faces competition in less developed countries, but as of now, it is the dominant player in South and Central America.
PayPal’s acquisition of Honey might not have made waves, but it was a shrewd play to capture a part of the bargain shopping space. The app functions as a browser add-on and as the user shops, it automatically generates coupons that can save money. While the app isn’t fully monetized as yet, the tough times that lie ahead certainly bode well for the increase of user numbers.
While Honey didn’t make headlines, PayPal’s acquisition of MercadoLibre most certainly did. Mercado is South America’s largest e- commerce website and far outstrips Amazon in that part of the world. Given the steady rise in users as well as increasing preference for online solutions, PayPal’s acquisition price of $750 million seems a pittance to pay for the company.
For comparison’s sake, the company generated $1.46 billion in revenue in Brazil alone in 2019.
PayPal is unique in that, unlike its competitors such as Square, it doesn’t have or depend on any in-person interaction. Square is focused more on developing point of sale solutions for merchants, but PayPal has famously stayed away from the business choosing instead to focus only on online payments.
Given the virus outbreak that the world has witnessed recently, this seems like a good decision. While PayPal certainly didn’t predict the outbreak, it deserves credit for understanding its business strengths and for sticking to it despite seemingly missing out on an important piece of the puzzle.
While this does increase its exposure to the digital space, and therefore increases its risks. The company is the oldest player in the space and has a wealth of experience to deal with any issues. Its presence around the world is also another sign of strength since it is well versed at this point in handling all regulatory hurdles that authorities put in place.
This places a high cost for newcomers to overcome and allows PayPal to effectively function as a monopoly.
While Visa and MasterCard are not traditional competitors of PayPal, comparing their financials to PayPal is far more instructive. This is because when it comes to online payments, these three are the only options available for the most part. Given PayPal’s focus on the online payments space and the credit card companies’ domination of in-person payment methods, you’d expect PayPal to suffer in comparison.
However, this isn’t true. Visa carries a far greater debt load on its balance sheet with assets just 1.3x debt. PayPal, on the other hand, is far less leveraged with assets at 7.8x debt. This means it is better suited to handle a downturn. The virus has disrupted the majority of credit card payments due to lockdown measures.
However, PayPal remains unaffected throughout all of this, and even if it were affected, it wouldn’t need to worry about creditors. It is in a great financial position.
PayPal has been expanding into the lending space and has recently received approval to fund SBA loans through its brand PayPal Credit. This is a major step forward for the company and marks the first time a payment processor is effectively functioning as a bank. While it remains to be seen how PayPal handles the vastly different business, investors don’t have too much to worry about.
First off, the size of the business is far smaller than the primary business and given its strong balance sheet, PayPal can afford to take a few risks. Given the economic climate that is likely to exist once lockdown measures lift, there will be a huge demand for loans and being a non- traditional lender will give PayPal a boost in terms of demand.
A potential risk that PayPal faces is from a phenomenon and not a single company. Blockchain technology has been disrupting existing security measures, and the demand for it grows as the days go by. PayPal is behind the curve with regard to this, and it does face significant security challenges.
This is even more relevant if it’s going to be providing loans. The risk here is public perception. While the company hasn’t faced any major data breaches, its growing size and reliance on seemingly outdated technology might cause an erosion of trust. As it is, PayPal is not well- liked amongst those who depend on it to receive payments from customers.
The lack of choice is what keeps merchants coming back. If consumers start feeling this way, then the company is in for a tough time. These risks are technological ones and given PayPal’s expertise in the space; we do trust that the company will handle it well. Its sheer size as well as its longevity, make it even more likely that PayPal will be a great company for many years to come.
Innovative Industrial Properties
Market cap – $1.24billion
52 week high/low – 139.53/40.21
Marijuana and medical cannabis have made a huge splash in recent years. The legalization of cannabis in select states in the United States and Canada has opened an entire market for investors to benefit from. The first instinct of many people was to invest in cannabis growers.
Initially, the returns were fantastic. Cannabis stocks rose exponentially for a period of two years but the party ended last year. These stocks fell to such an extent that almost all of them are back to their IPO levels. All in all, while the industry itself has been growing, increasing competition and a strangely efficient black market have ensured that individual companies are facing stiff headwinds.
All of this sounds quite familiar to business historians. We’ve already mentioned how savvy investors got rich during the gold rush. The same 2nd order consequences principle applies here as well. While everyone is scrambling in a mad dash to grow marijuana and sell them to a public that has been demanding it for years, savvy investors recognize the things that all of these companies need.
There really are two needs when speaking of growing marijuana: Fertilizer and land. As far as fertilizer goes, it isn’t as if the plant needs anything special, so there’s not much of a moat to be found there. This leaves land, and this is what brings us to marijuana REITs. We’ve mentioned REITs before when speaking of Crown Castle and how these companies are obligated to pay out 90% of their net cash earnings to their investors.
Innovative Industrial Properties (Innovative) has what is probably the most boring name a company can have, but don’t let that put you off. It has a simple business model and utilizes its industry advantages well. It leases land to marijuana growers and earns the rent paid on it. The best part is that the high demand for land to grow marijuana on means that the lease payments are much higher than what you would find when leasing farmland or office space.
This is reflected in the high dividend yield that the company offers its investors. As of current writing, this is at 5.8%, which is almost double that of what a diversified REIT would pay. A diversified REIT invests in a portfolio of properties across functions such as rental real estate, commercial real estate, farmland, hospitals. In short, marijuana suited land is fetching almost double the yield of regular real estate. This is truly a spectacular return.
One of the advantages that strict legislation in marijuana provides is that lease agreements can be changed from what their terms usually are. This means that all of the properties Innovative provides for lease requires the tenant to pay not just the rent but also the property taxes and maintenance. In industry parlance, such leases are referred to as triple net leases.
This leads to Innovative earning an average cap rate of 13% on its properties. Cap rate refers to the cash return REITs make after all expenses are accounted for. For comparison’s sake, the average cap rate of a commercial REIT that leases office buildings is 4%.
This allows Innovative to pay off its mortgage within a seven-year period and after that everything is a profit. We must mention that cap rates are this high right now due to the lack of federal legality. This allows Innovative to charge higher than normal market rates for its properties.
We expect that cap rates will return to normal once legality kicks in across the board. For now, though, rates remain high. The structure of the lease also allows Innovative to incur reduced costs on its properties. Typically, REIT companies have to carry out maintenance and upkeep of their properties.
In Innovative’s case, their triple net leases mean that costs are low. While this lowers rental payment as well, it isn’t as if it sinks to below market price levels.
Given that the marijuana industry, at least the legal one, is still immature, there are significant risks the company faces. While it has isolated itself from the majority of fluctuations in the business by becoming a supplier, there are risks nonetheless. Strangely enough, legislation is what provides a threat.
Federal legislation will see rents dropping and leases returning to regular terms, and this will reduce the income that Innovative earns. Growth is what will offset this drop, and in this regard, the company has been doing a great job. It owns over 3.8 million acres of rentable property across the United States and given the high cash on cash return the company earns; expansion is not going to be a problem.
As of now, the company not only pays a high dividend but also pays it quarterly. We expect this amount to decrease a bit as time goes on. These are regular risks that all REITs are exposed to. As long as Innovative sticks to its expertise in the marijuana field and resists the temptation to move into something else, its prospects remain great, and it is a great way to get exposure to the marijuana industry, without the risks of directly investing in growers.
Market cap – $15.34 billion
52 week high/low – 128.48/66.29
This is yet another stock that is going to feel the boost that 5G will bring this year. 5G is one of the most anticipated technological advances the markets have witnessed in a long time, and that’s saying a lot. The technology will provide up to 100 times the speeds of current 4G/LTE networks.
Such speeds are necessary for the development of the internet of things related devices such as smart appliances and driverless cars. Skyworks is a company that manufactures RC chips for smartphone manufacturers and home automation manufacturers. In other words, the semiconductor chips that are a part of every 5G electronic device will likely come from Skyworks.
Currently, 5G phones are expected to comprise 12% of the smartphone market, with the number doubling in 2021 as the technology catches on. This means that the best days for Skyworks are yet to come. Currently, it is a supplier to Apple and Huawei, and if you’ve been paying attention to the 5G political picture thus far, you’ll notice that this is a problem.
The trade war with China and the banning of Huawei from doing business with all American entities has meant that Skyworks has seen its revenues take a hit. This has led to its stock tumbling as the current administration’s trade war continues to twist and turn without an end in sight.
However, this isn’t bad news for Skyworks as far as the long term is concerned. The technology itself isn’t going anywhere, and the company remains the leader in its space. It is more likely than not that increasing demand from consumers will lead to more customers for Skyworks and the reliance on Huawei will be a thing of the past.
To offset this loss, the company has begun including smartphone makers Oppo, Vivo and Xiaomi to increase revenues. Its largest customer remains Apple, and this is a double-edged sword. First off, no company wins the business of Apple unless it happens to have exceptional quality, and Skyworks has been the preferred supplier for many years now.
However, its fortunes are joined at the hip with Apple’s, and if the latter faces any challenges with its business, then Skyworks will likely sink with it. Given Apple’s size, this is an unlikely event but it remains a risk nonetheless.
The best part of Skyworks is that the company is in an extremely sound financial position when compared to its other 5G peers. It has virtually zero debt on its balance sheet, and this puts it in prime position to expand and take more risks should the need arise.
It isn’t just the past year but in fact, the last five years that have witnessed debt-free growth. The current pandemic has forced some of its competitors to cut back but Skyworks is now free to expand and conduct business as it pleases. The stock has suffered due to overvaluation that all 5G stocks were subject to.
As we mentioned earlier, a lot of 5G stocks were selling at inflated prices, and once the bubble burst earlier this year, all of these stocks came tumbling down. Skyworks is no different. It got caught up in the general hysteria surrounding the sector and is now selling at a very attractive earnings multiple of 19x.
The main strength of Skyworks is its management without a doubt. They are honest to a point and are incredibly frank when discussing the company’s shortcomings on earnings calls.
However, this only reaffirms that the management knows what it’s doing, and being conservative in what is an extremely popular sector is good for the long run. All of these will stand Skyworks in good stead, and investors will benefit from this.
Skyworks meets all of our investment criteria, and by reviewing all of them, you’ll understand why we highly recommend Skyworks as a long term investment.
This brings to an end our look at the 20 best stocks for you to hold for the next 20 years. All of these companies are wonderful investments, and you’ll do well to buy into them at fair prices. Speaking of fair prices, let’s move on to an important section of this guide – How to value a business.
Read Books to Learn The Right Investment Mindset
A large part of successful investing is about Mindset. So I read many mindset books.
Recently, I read Rich Dad Poor Dad and found it quite interesting.
Through autobiography and personal experience, Rich Dad Poor Dad explores the steps to becoming financially independent and wealthy.
The writing style and framework of this book are narratives. This book focuses primarily on anecdotes with nuggets of supposed wisdom, not technical insight or investment math.
He compares the lessons he learned from his biological father (an intelligent, but financially inept father) with the lessons that he learned from his friend’s father (an uneducated, but smart and wealthy father).
It weaves through Kiyosaki’s life as he learns from his rich father and rejects advice from his poor father (thereby eclipsing typical working-class mindsets).
Some of the concepts in this book are, however, questionable. Read my Rich Dad Poor Dad review to learn more about my insights about the book.