CIO Insights - 21 June

Hi everyone
 
Congratulations to Jon Rahm, who this morning became the first Spaniard ever to win the US Open golf tournament, fending off a host of previous Major winners in the process. Louis Oosthuizen might just be South Africa’s version of Greg Norman, having completed the Grand Slam of Runner-Up Major finishes. Gotta love that swing though!
 
Anyway…
 
After releasing the May Monthly Investment update, where I made mention of the leaders and laggards for the month in our conference portfolio, a shareholder asked me a great question, which I thought was worthy of talking to our greater audience about. The stock in question was Teladoc Health Inc, which provides virtual healthcare services on a business to business basis in the United States and internationally. Teladoc was pitched by Cathie Wood from ARK Invest, who I’m sure you will recall pitched Tesla at our 2019 conference, which went on to rally some 600% over the course of the next 12 months.
 
In May, Teladoc was down 15%, and was the biggest detractor to performance for the month. This prompted Mark to ask me whether it was an exception to the general investment criteria and strategy of the fund to have a holding in a loss-making business.
 
The first thing anyone learns in business class is that companies cannot continue to make losses indefinitely and expect to survive. It follows from that to question why a high conviction fund (or any fund for that matter) would choose to invest in a loss-making company given there are thousands of profitable companies out there?
 
I’m going to talk about this in two parts – investment opportunities generally, and the X-factor that HM1 has with our conference portfolio timeframe.
 
Firstly, a few companies you’ve all heard of that were (and some still are) loss making. Amazon. Tesla. Spotify. Netflix.  What they all have in common is that they are disruptors. Amazon with the way we buy things; Tesla with electric car technology; Spotify with how we listen to music; and Netflix with how we watch TV. All of them have been large loss-making businesses, and indeed some of them still are, yet their share prices have delivered shareholders incredible returns, especially Amazon, whose share price has increased from $1.50 when it listed in 1997 to over $3,000 today!
 
If a company can demonstrate to investors that it has a potentially game changing technology or product but will need to re-invest heavily in its early days to build an economic moat and get as far ahead from its competitors as possible, and management have some sort of track record of delivering on their promises, then there will be no shortage of investors willing to back these companies, despite reporting losses at the time.
 
We all saw what Tesla did in 2019/2020 as the world woke up to the fact that electric cars will be mainstream far sooner than anyone really thought, and that Tesla were so far ahead of the competition with its battery technology and the data it had collected (12 billion miles of data vs 20 million miles by the competition). The stock rose astronomically, despite racking up loss after loss each quarter, which technically they still do, given the revenue they receive through selling emissions credits to the competition is covering the production losses they still incur. Fortunately, HM1 shareholders were able to benefit from the share price gains over the 12-month period after Cathie pitched her thesis to the audience in November 2019.
 
Secondly, to re-iterate how the HM1 portfolio is actually constructed regarding the holding period of stocks. The core portfolio, which comprises three recommendations from each of our six core portfolio managers, represents 65% of our investment portfolio. These stocks can be held indefinitely, and indeed about half of the core portfolio has been held since inception (allowing for TDM’s inclusion in 2019). The conference stocks are held for a maximum of 12 months. They are replaced by the new conference recommendations each November. Given the shorter time frame for these stocks in our portfolio, our conference managers understand that there really needs to be an identifiable catalyst for a share price re-rating within the 12 months, and this is the X-factor.
 
Given the frequency of profit reporting (quarterly in the US, 6-monthly locally) and the need to keep the market informed of any profit variability, more likely catalysts will be around the development of technologies, expansion of geographies, acquisition of competitors, or increases in user/subscriber numbers. And this is what we have seen with many of the conference stocks we’ve held over the past three years. Tesla, DocuSign, Yeahka, Hello Fresh, Spotify, Slack Technologies, just to name a few, have all delivered HM1 with excellent returns, despite the companies making little or no profits at the time.
 
We take manager selection extremely seriously, and we know that they are best of breed subject matter experts who are completely focused on finding the companies most likely to deliver our shareholders the best investment returns in the given timeframes – be it 12 months for conference managers or indefinite for our core managers.
 
Hopefully this gives you a little more insight into what our managers look for when searching for companies to invest in, and it is often far deeper than top line profitability.

This piece was inspired by a readers’ question, so if there’s something you want me to write about, or have any questions, as always, feel free to come through via email.

Stay safe

Rory Lucas
Chief Investment Officer
Hearts and Minds Investments Limited

Reminder: these are simply my general views and should not be taken as investment advice

 

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DISCLAIMER: This communication has been prepared by Hearts and Minds Investments Limited (ABN 61 628 753 220). In preparing this document the investment objectives, financial situation or particular needs of an individual have not been considered. You should not rely on the opinions, advice, recommendations and other information contained in this publication alone. This publication has been prepared to provide you with general information only. It is not intended to take the place of professional advice and you should not take action on specific issues in reliance on this information. Past performance is not a reliable indicator of future performance. This document may not be reproduced or copies circulated without prior authority from Hearts and Minds Investments Limited.