It has been a volatile reporting season. The wonderful businesses we own generally had outstanding results. Alphabet continues to dominate with 37% growth in earnings.We are very comfortable with this as our second largest holding.
Microsoft grew earnings at 24%. Their cloud business continues to outgrow the rest of the company and is becoming an increasingly dominant part of their earnings. We expect their cloud business to continue to grow at high rates for several years as companies consume ever more amounts of data.
Amazon retail sales were slightly slower than we expected, however their AWS sales reaccelerated with 41% growth.
Fiducian had continued solid growth with 19% growth in revenues. Their acquisition of Peoples Choice Credit Union in South Australia, which was recently completed from their spare cash, should maintain this growth over the next few years.
Markel is still growing solidly with 12% revenue growth; however, we are excited about their future growth machine in Markel Ventures which grew revenues at 30% per annum.
Unilever had weaker than expected results due to cost pressures. They have been raising prices, which led to 4.5% revenue growth, however we have noted that their pricing power is weaker than we expected during this period of higher input inflation.
Meta (formerly Facebook) grew revenues at 20% per annum. The market did not like their forward guidance and increased investment in the Metaverse and drove the shares down 26% in one day. The shares were undervalued before the fall, and they are now significantly undervalued under most scenarios. Morningstar values the shares at $400 a share whilst the current share price is only $220 a share. Our valuations are not dissimilar.
“In the short term, the share market is a voting machine, in the long term, it is a weighing machine. “ (Ben Graham)
We are very confident that Meta will tip the scales over the coming years.
Share buybacks at these levels are highly accretive and could grow earnings per share at over 7% more than revenue growth over the medium to long term if the shares remain significantly undervalued.
We have repeatedly reminded part owners of businesses, the best thing that can happen if you are a long-term shareholder in a company cannibalising its stock, is that the share price goes down not up. We are very excited about Facebook share buybacks at these levels.
Instagram continues to thrive. Whilst I speak to many who say they don’t use Facebook much anymore, they all freely admit to using Instagram, Messenger, WhatsApp or the new growth business which is Facebook Marketplace. If you are looking to buy or sell anything second hand, Facebook Marketplace is the place to be.
What is the Metaverse?
My dad was an international pilot and when I was growing up, he almost never called home. This was not a reflection of him as a dad, he was a wonderful father, it was a sign of the times. International calls would cost him a decent chunk of his weekly pay packet for an hour-long phone call. If you told a person in 1985 that high-definition video calls would be free within 25 to 30 years, they wouldn’t have believed you. Whilst few could envision the connectivity of families (including grandparents and preschoolerspre-schoolers) getting together on Zoom during the Covid lockdowns, few have the same foresight to see what is possible with virtual reality (VR) over the coming decade. Meta CEO, Mark Zuckerberg, believes that the Metaverse is the future of human interaction.
In other words, the Metaverse is simply a virtual reality world in which people interact for work, social and play. Meta (I still call it Facebook in the same way I continue to call Alphabet Google), is building this platform and hopes that users buy their Oculus headsets to enter this new and exciting world.
I first used a virtual reality headset in 1997 to play a flight simulator game. It was ok, however it wasn’t amazing. The technology is now ready to become mainstream.
The current technology and future iterations are likely to transform the way we connect both socially and at work.
Imagine being in a work meeting and using a VR headset to three dimensionally “see the wall” of a business plan. Being able to work with colleagues remotely with a VR headsetand build a wall of connected data such as in the movie Minority Report with Tom Cruise will be revolutionary.
Walking through an open house inspection to not only see what the current house looks like, but to also see the possibilities of what future renovations could be, will change the way we inspect houses. Education through experience in life like situations that virtual reality allows can accelerate learning by immersing students in a far richer environment. Those that have taken children on a family holiday and witnessed the development leap from experience will understand this.
Today we are limited to what we can see and do by the two-dimensional 6-inch to 21.5-inch screens we spend much of our daily lives addicted to. In the future, adding in a third dimension and making it virtual, opens limitless possibilities for presentation and connection and has the ability to change the world.
Humans are extraordinary creatures that our subconscious mind is far more powerful than we realise. Our conscious minds can only focus on around seven items at a time. If you have played the tea towel memory game, whereby you lay out 30 items under a tea towel, you will realise that without memory techniques, almost every human being can only remember 7 or so items.
Two-dimension presentation of data, as is the case with current screen technology is largely structured to work within our conscious mind's seven item limitation. With the Metaverse, the number of items that our whole minds will be able to “see” is in the thousands and our subconscious mind can become a much larger active component in our decision making. If a picture speaks a thousand words, then a 3D Metaverse presentation is worth ten thousand words.
The future Metaverse investments of around $10 billion a year are a fraction of their $57 billion (and growing) operating cash flow. Mark Zuckerberg has the runs on the board with his initial Facebook app, Instagram acquisition, WhatsApp acquisition, Facebook Market place innovation and other smaller innovations (and successful imitations). We trust his vision for the future in this area. The probability of the Metaverse being a significant earner for Meta is more than reasonable. If they invest $50bil and it turns into a multi-hundred billion business, then it is a solid investment. If they fail, then the fall in the current share price will be worth more to shareholders than this $50bil investment due to accretive buybacks. In other words, it’s heads we win, tails we win a lot.
Magellan Further bad news hit the Magellan share price in the last month. Hamish Douglass has taken indefinite leave. This has led to further institutional outflows from the Global Fund. Chris Mackay, who founded Magellan with Hamish, has taken the reins and we are more than comfortable with his excellent investment track record and capabilities. Whilst these negative developments have been front page news, what is little discussed is the diversification of Magellan and the continued growth in many of the non-Global Fund businesses. The infrastructure fund run by Gerald Stack has had a solid period in not only the investment performance, but with net inflows. Airlie, their Australian Funds management business is still growing at a reasonable pace with net inflows. Barrenjoey is profitable before even the most optimistic observer expected and is likely to grow solidly over time. Guzman y Gomez is growing solidly with continued growth in new stores expected over the coming years. Finclear had a valuation of three times what Magellan paid for it. When we calculate the value of the non-core assets such as Barrenjoey, Gusman and Gomez, Finclear, the spare cash, ownership of their own funds and the value of their closed end fund management businesses, we find that the value of these assets is not far below the current market capitalisation. This leads to the conclusion that the remainder of the fund management businesses are being priced for implosion. With the performance of the Infrastructure Fund and Airlie and their net inflows, this is unlikely. There is much discussion around investment performance in the investment industry which is chronically wrong. There are different investment styles for different people that are appropriate for each stage of life. Magellan has a conservative investment style that works for people who are already wealthy. Their less aggressive investment style will almost always underperform in crazy markets like we saw in 2021. A 20-year-old living in their parents’ basement with a few thousand dollars to their name should have a very different investment profile to a 65-year-old who has a few million dollars to live off for the rest of their life.
Up until November last year, many of the stocks which had performed well were the ones that a 65-year-old with a few million to live off for the rest of their life should have been avoiding. The loss making (often fraudulent) growth stocks which promised to change the world through disruption were trading at nosebleed prices. Many who invested in these story stocks became temporarily wealthy. A number of these stocks are now down between 50% to 80%. With negative cash- flows and the kindness of strangers required to keep the lights on, there is no floor for some of these businesses.
This style of investing may be fine for the 20-year-old whose future wealth is almost entirely attributed to their income from personal exertion. It is not fine for the 65-year-old whose future income is almost entirely attributed to the earnings of their investment portfolio.
There should be a very simple phrase on the Product Disclosure Statement (PDS) stating the investment style of the manager: We are a get rich risky investor or a stay rich conservative investor. Comparing the performance of a get rich risky investor to a stay rich conservative investor is asinine at the top of the market, yet that is what the media did for Magellan. When you look at Magellan’s long-term track record, their major outperformance came during the 2007 to 2009 50% fall in the market. Criticising them for underperforming during the bubble markets of 2021 is unfair to their commitment to preserve capital. They should absolutely underperform during speculative frenzied periods from time to time. Warren Buffett was similarly criticised for his underperformance in 1999, right before the period where the Nasdaq dropped 80% and didn’t recover for 13 years.
We remain confident that Magellan’s investment track record will do well throughout a full cycle. In the meantime, we expect to receive a grossed-up dividend of approximately 14% per annum.
Looking for quality at fair price With several growth stocks down 30% to 50%, we are excited about potential investments to add to our portfolios. We remain skeptical of companies that are yet to prove that they can turn a profit. Unprofitable growth is not an area we wish to participate in as there is no floor to these businesses if capital markets become tighter as was during the 2000 to 2003 period. I recently read the book “The hard thing abouthard things” by Ben Horowitz,which discusses the difficulties of running a business during the early 2000’s. During this period, capital markets essentially froze for loss making internet businesses. Very few tech companies could raise equity or debt for a few years. There are numerous businesses today that are burning cash and playing musical chairs hoping the music doesn’t stop. Several of the growth stocks that are on our ‘safety-first’ watch list remain at valuation levels which make the investment case not obvious. We have a portfolio of wonderful businesses and for a new investment to replace any of the current investments, it needs to be a cash cow with a long platform for global growth at a reasonable price. This thins out the herd of potential future investments quickly in this market, particularly with share-based compensation consuming an excessive proportion of owner’s earnings.
We recently analysed a wonderful business which had three quarters of its free cash flow going to employees’ pockets and not the shareholders through share issuance. Whilst this is excessive, the risk is also that if the share price falls, employees who are expecting their shareholding to appreciate can get itchy feet, which can make retaining employees more difficult.
We continue to search for wonderful businesses for your portfolios to continue to grow your money consistently over time.
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