We covered our thoughts and reflections on the past year in our “2020 Won’t Soon Be Forgotten” article (link here), and now we are looking towards the future. Global health authorities should be able to bring an end to the ongoing coronavirus (‘COVID-19’) pandemic sooner than many had expected as several vaccines have already been improved for emergency use and several others appear increasingly likely to get approved. Global vaccine distribution activities are currently underway, and this should allow the world to slowly return to pre-pandemic activities. Before then, immense stimulus measures launched primarily in developed nations should support global economic activities until the public health crisis is put to an end, establishing a positive outlook for the upcoming year.
With that said, 2021 may be no less stressful an environment than 2020, with systemic risk rearing its ugly head. In the early days of 2021, “bull raids,” or aggressive and orchestrated “short squeezes” on stocks, have translated into excessive volatility and irrational market behavior driven in part by Reddit WallStreetBets (WSB) users and Robinhood traders and exacerbated by price-agnostic trading from traditional quant algorithms. The posterchild of the times has been GameStop (GME), the shares of which went from a 52-week low of $2.57 in March 2020 to a 52-week high of $159.18 in January, and are now trading at ~$50-$70 per share at the time of this writing–still far above what may be considered to be a fair value estimate of the equity.
There have been more instances of crazy market behavior so far in 2021, too. Other heavily shorted stocks including Express (EXPR), Macerich (MAC), Bed Bath & Beyond (BBBY), and AMC Entertainment (AMC) have become tools of trading madness. As with the “fad” of investing in bankrupt companies in 2020 when the Robinhood crowd whipsawed prices of Hertz (HTZ), Whiting Petroleum (WLL), GNC (GNC) and Chesapeake Energy (CHKAQ) among others, in early 2021, the trading sharks circled heavily-shorted names to drive aggressive short-squeezes, often in conjunction with the application of deep out of the money call options. Several overextended hedge funds felt the pain.
Though we reiterate our fair value estimate of the S&P 500 is $3,530-$3,920 based on common-sense normalized expectations, we also believe that systematic risk is increasing as price-agnostic trading continues to proliferate across the market. Fewer and fewer investors are paying attention to intrinsic value estimates, and this could have severe implications on the health of the global financial system. With that said, let’s walk through key fundamental themes touching on the spaces of technology, e-commerce and retail, fintech and payment processing, energy and oil/gas, green energy, biotech and healthcare, 5G wireless, old industrial, video streaming, traditional banking, and cryptocurrencies.
We hope you enjoy. Here’s to a great 2021!
Technology
Stocks in the information technology sector performed incredibly well in 2020, all things considered, and we expect that will continue in 2021. Though one could argue that the COVID-19 pandemic pulled forward demand for certain tech offerings, meaning growth will be harder for certain firms to come by going forward, we see recent trends as a sign that the digital transition is accelerating.
For instance, digital advertising was already steadily becoming a larger part of total advertising spending given the highly targeted and flexible nature of these campaigns. GroupM, a division of WPP (WPP), forecasted that 2020 could be the first year digital advertising represents over half of all advertising spending in the US (when excluding political ad spending). Looking ahead, we expect digital advertising will continue to grow in both relative (as a percent of total ad spending) and nominal terms, with GroupM forecasting US digital advertising to continue to take market share in 2021.
The outlook for the global digital advertising market is quite promising due to the rise of the “global middle class” (higher incomes supports greater revenue per user) and rising Internet penetration rates in emerging economies (creating new growth opportunities). We continue to be huge fans of Alphabet (GOOG) (GOOGL) and Facebook (FB) given their dominant positions in the digital ad industry.
Both companies have pristine balance sheets, stellar cash flow profiles, high-margin businesses, promising growth outlooks and are trading well below their intrinsic value estimates (as of this writing) which is why we include both Alphabet Class C shares and shares of Facebook in the Best Ideas Newsletter portfolio. To read more about Alphabet, click here. As it relates to anti-trust concerns facing Facebook, we are not concerned as a breakup of the firm could counterintuitively see its share price converge toward our estimate of its intrinsic value at a faster pace than as a standalone company (we covered this in detail here).
Another realm that has experienced strong growth of late, and will likely continue to do so, is cloud computing. Microsoft (MSFT) has witnessed sales at its cloud-focused Azure business segment surge higher in the recent past, supported by its big data analytics offerings (more on MSFT here). Though Amazon (AMZN) has long been a leader in the cloud-computing space in terms of market share, Microsoft is starting to catch up. Even Alphabet is starting to see its Google Cloud unit start to gain some traction while Oracle’s (ORCL) cloud-oriented businesses have performed well of late, which helped lead to management issuing favorable near-term guidance during Oracle’s latest earnings call (more on ORCL here). We include shares of ORCL in our Dividend Growth Newsletter portfolio.
Third-party market research service Research and Markets forecasts the global cloud-computing market in terms of revenues will post compound annual growth rates in the high teens through 2025 (versus 2020 levels). With a greater number of employees now working from home, enterprise IT needs have fundamentally changed as there is a now much greater need for flexible productivity offerings that can be securely accessed.
Microsoft’s telecommunications-focused Teams service is integrated with its other products and services, such as Dynamics 365 (focuses on enterprise resource planning and customer relationship management applications), highlighting the company’s ability to cross-sell and upsell its various offerings to enterprises large and small (made possible by Microsoft’s focus on cloud-oriented services). We include Microsoft in both the Best Ideas Newsletter and Dividend Growth Newsletter portfolios.
Cybersecurity needs are on the rise. The recent SolarWinds (SWI) hack, which US intelligence agencies view as being conducted by Russian entities with ties to the Russian government, further highlights the need for top-tier cybersecurity offerings. Crowdstrike (CRWD), Okta (OKTA), and Zscaler (ZS) are three top-tier cybersecurity-oriented firms that provide their offerings via Software-as-a-Service (‘SaaS’) delivery methods. The Russian hacking group attempted to break into Crowdstrike’s operations via the SolarWinds hack but was ultimately unsuccessful. All three of these companies were investor favorites in 2020, and we expect that interest in companies operating in the cybersecurity space will remain elevated throughout 2021, especially for SaaS firms.
In our view, demand for dynamic cybersecurity services will continue to grow at a brisk clip going forward. The need to secure sensitive information and the potential cost of that sensitive information getting stolen underpins our optimistic outlook towards the space. Sony (SNE) was hacked by a North Korea entity in 2014 that saw sensitive information about Sony’s employees released to the public along with several movies that had yet to be released.
The potential damage hacks can have on a company is immense, especially if that company’s core business model is built around storing sensitive information regarding its customer and/or user base. Equifax’s (EFX) public image took a big hit when it was hacked (the hack was announced back in 2017), and the firm was forced into a multimillion dollar settlement.
Third-party research service Grand View Research forecasts the global cybersecurity market will increase by a 10% compound annual growth rate from 2020 to 2027. Companies are likely willing to pay up for top tier cybersecurity offerings, in our view, which further supports the outlook for the industry given the favorable impact pricing power can have on operating margins.
E-Commerce & Retail
Pivoting to e-commerce, the recent surge in households turning to e-commerce firms like Amazon to meet their routine needs such as groceries, toilet paper, and other consumer staples products via home delivery options has legs. Third-party market researcher eMarketer predicts that US e-commerce sales grew by over 32% annually in 2020, climbing to north of $790 billion from about $600 billion in 2019. By 2024, eMarketer views US e-commerce sales hitting $1.2 trillion. An increasing number of purchases across all types of product categories (from groceries to clothes to appliances and more) will be made online all over the world going forward, in our view.
Traditional retailers that invested heavily in home-delivery, curbside pickup, and in-store pickup fulfillment options and their digital operations more broadly (having an e-commerce platform that is easy to use) were well prepared when the COVID-19 pandemic hit. Dick’s Sporting Goods (DKS) and Home Depot (HD) are two prime examples of companies that were able to lean on their past investments in omni-channel sales capabilities and meaningful digital investments to ride out the storm while generating impressive same-store sales growth (more on DKS here and HD here).
Dick’s Sporting Goods has placed a big emphasis on improving its mobile app over the years(the source of over half of its e-commerce sales in the third quarter of fiscal 2020), such as integrating the app with its popular customer loyalty program. This strategy has proven to be a boon for the company. Home Depot continues to benefit from strong do-it-yourself (‘DIY’) demand as households pursue home improvement projects while stuck indoors due to COVID-19. These customers are increasingly turning to Home Depot’s e-commerce platform to place orders online and pick up in-store. Additionally, Home Depot is well-positioned to meet strong demand from the domestic housing market as it has a top notch professional-facing business. We include both firms in our Dividend Growth Newsletter portfolio.
Dollar General (DG) has made significant improvements to its digital operations in recent years, though the firm still relies on its physical presence to meet demand. Given that Dollar General focuses on small cities and towns in the US with populations of 20,000 or less, we view its business model as being well-insulated from e-commerce competition due to the logistical hurdles that companies face when attempting to meet demand in these remote regions via home delivery fulfillment options. We include Dollar General in the Best Ideas Newsletter portfolio and continue to be impressed with the stellar same-store sales growth the retailer has put up of late (more on Dollar General here).
Fintech and Payment Processing
One of the dynamic effects the rise of e-commerce has had on the global economy involves creating greater demand for online-oriented payment processing services. PayPal (PYPL) is one of our favorite companies in this space as its growth outlook is stellar, supported by its high-quality cash flow profile and pristine balance sheet. The firm also owns Venmo, the popular peer-to-peer money transfer mobile-oriented app, and we are excited about the numerous ways PayPal could monetize this business. After separating from eBay (EBAY) in 2015, PayPal has steadily grown its total payment volume (‘TPV’). Its TPV was up 36% year-over-year on a constant currency basis in the third quarter of 2020.
The ultimate end game of the fintech and payment processing space is to create a “walled garden” where companies can provide multiple services at once with limited competition in certain instances. For instance, if a customer buys something online and that product is located overseas in a country with a different currency, PayPal can make money both by processing the payment and by providing foreign currency transaction solutions, along with any other required service (without necessarily being compelled to provide other options to the customer for each individual service).
