A summary of this week’s best articles. Follow us on Twitter (@INTRINSICINV) for similar ongoing posts and shares.

FOR COMPANIES, IT CAN BE HARD TO THINK LONG TERM (John D. Stoll, @johndstoll, WSJ)

Apple recently announced that it will no longer be reporting on their quarterly sales numbers in an attempt to focus investors’ attention on long-term results as opposed to short-term ones.  This announcement is part of an ongoing debate around the focus on short-term versus long-term thinking on Wall Street.  Should companies report less frequently than quarterly?  What are the potential market consequences on either side?

AUDI TO SPEND NEARLY $16 BILLION ON SELF-DRIVING CAR TECH, ELECTRIFICATION THROUGH 2023 (Kirsten Korosec, @kirstenkorosec, TechCrunch)

Audi announced recently that they will invest significant capital into continuing to develop their self-driving and electrification technology.  Car manufacturers globally are looking to keep up with the future of transportation by investing significant capital into self-driving, electric cars.

THE FRIENDSHIP THAT MADE GOOGLE HUGE (James Sommer, The New Yorker)

In the year 2000, Google almost collapsed when a cosmic ray from a supernova hit one of their server chips and flipped a binary bit from 0 to 1 corrupting their index of the web.

MILLENNIALS DIDN’T KILL THE ECONOMY.  THE ECONOMY KILLED MILLENNIALS. (Derek Thompson, @DKThomp, The Atlantic)

The Millennial generation gets blamed for a lot of the economic woes of today’s era, but are they really the ones to blame?  “Millennials were promised rising wages, homes, and cars; they got 140 characters. Okay, fine, 280 characters. That’s nothing to live on. But it’s just enough to efficiently articulate one’s despondency alongside 80 million frustrated peers, all of whom are exasperated with a system that keeps finding new ways to brand its young economic victims as cultural criminals.” Sean Stannard-Stockton also recently wrote about what the millennial generation means for the economy and investing.

HUAWEI EXECUTIVE’S ARREST INTENSIFIES TRADE WAR FEARS (Mark Landler, Edward Wong and Katie Benner, New York Times)

Intensifying trade war fears have been cited as a key reason for much of the downward market pressure of late.  Concerns increased this week as Meng Wanzhou, a top executive of one of China’s flagship technology firms, was detained for allegations that her company, Huawei, has been violating sanctions on Iran.

FED WEIGHS WAIT-AND-SEE APPROACH ON FUTURE RATE INCREASES (Nick Timiraos, @nicktimiraos, WSJ)

While Thursday December 6th felt like a down day in the markets, it was really a down morning followed by a massive 700 point rally in the Dow. This article is being cited as the reason for the rally.  The news, however, isn’t all that new and is consistent with what the Fed has communicated to date.  A pause after December would still potentially be consistent with two additional rate hikes in 2019.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

The information contained in this post represents Ensemble Capital Management’s general opinions and should not be construed as personalized or individualized investment, financial, tax, legal, or other advice. No advisor/client relationship is created by your access of this site. Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. If a security discussed in this blog entry is owned by clients invested in Ensemble Capital’s core equity strategy you will find a disclosure regarding the security held above. If reviewing this blog entry after its original post date, please refer to our current 13F filing or contact us for a current or past copy of such filing. Each quarter we file a 13F report of holdings, which discloses all of our reportable client holdings. Ensemble Capital is a discretionary investment manager and does not make “recommendations” of securities. Nothing contained within this post (including any content we link to or other 3rd party content) constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instrument. Ensemble Capital employees and related persons may hold positions or other interests in the securities mentioned herein. Employees and related persons trade for their own accounts on the basis of their personal investment goals and financial circumstances.

I recently read a tweet from a European investor who shared the following quote from an unnamed CEO: “If we can’t forecast it, what chance have you analysts got?”

It’s a fair question. Indeed, analysts like me who base our valuation models on estimated cash flows should recognize we have limited visibility as outside shareholders. If the company’s insiders can’t confidently forecast cash flows, our efforts may be pointless.

Exercise in futility?

Whether we’re evaluating a new company or monitoring an existing company, a key question in our confidence framework is, “To what extent is this business intrinsically forecastable?”

On one extreme, a company can have a simple, straightforward business model with steady cash flows. Only a few of our portfolio companies get a top score from us in this category. One is Mastercard, which benefits from a secular shift away from cash payments and operates as a “tollbooth” of sorts for general consumer spending. Despite recessions along the way, the trend of U.S. consumer spending has marched steadily higher with time.



source: tradingeconomics.com
 

It’s worth noting that our scores are relative. No company is free from uncertainty.

We aim to avoid investing in the other extreme, which is a complex business model with highly uncertain cash flows. A “complex” business may have a complicated or opaque operating structure, or there may be inaccessible key information. These factors can make cash flows relatively difficult to forecast. For any success, these companies need to catch just the right wave at just the right time.

Naturally, companies with relatively predictable cash flows tend to trade at a premium valuation to companies with more uncertain cash flows. Value opportunities are less frequent in the former category than the latter. As such, we consider this topic alongside other moat, management, and business model-based questions. Indeed, we love opportunities where the market confuses short-term and long-term uncertainty regarding a high-quality business.

Make a call

But this may be missing a more important question: “Why forecast at all?”

When you invest in a company, you are either implicitly or explicitly making assumptions about the company’s future. Even if you buy a stock because it has a low price/earnings ratio and don’t do a cash flow forecast, the market-driven multiple nevertheless contains implicit assumptions of future growth and uncertainty.

We’ve found that by explicitly estimating cash flows in our valuation models, despite recognizing that our estimates will be wrong to some degree, it naturally generates important questions.

For example:

  • Are the company’s targets for revenue growth and profit margins realistic?
  • Are returns on invested capital improving or deteriorating?
  • Can management fund its buyback, dividend, or debt repayment plan with free cash flow?

We believe such questions are relevant to a part-owner of the business as opposed to a renter/trader of the stock.

Bottom line

Without uncertainty there is no opportunity. If the market had perfect knowledge of a company’s future cash flows, the stock’s return would approximate Treasuries.

As such, we need to be comfortable with uncertainty in our pursuit of higher returns. We believe that by explicitly forecasting cash flows and asking better business-focused questions, we can more fully appreciate the opportunities and risks faced by the company.

As of the date of the post, clients invested in Ensemble Capital Management’s core equity strategy own shares of Mastercard (MA). This company represents only a percentage of the full strategy. As a result of client-specific circumstances, individual clients may hold positions that are not part of Ensemble Capital’s core equity strategy. Ensemble is a fully discretionary advisor and may exit a portfolio position at any time without notice, in its own discretion.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

The information contained in this post represents Ensemble Capital Management’s general opinions and should not be construed as personalized or individualized investment, financial, tax, legal, or other advice. No advisor/client relationship is created by your access of this site. Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. If a security discussed in this blog entry is owned by clients invested in Ensemble Capital’s core equity strategy you will find a disclosure regarding the security held above. If reviewing this blog entry after its original post date, please refer to our current 13F filing or contact us for a current or past copy of such filing. Each quarter we file a 13F report of holdings, which discloses all of our reportable client holdings. Ensemble Capital is a discretionary investment manager and does not make “recommendations” of securities. Nothing contained within this post (including any content we link to or other 3rd party content) constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instrument. Ensemble Capital employees and related persons may hold positions or other interests in the securities mentioned herein. Employees and related persons trade for their own accounts on the basis of their personal investment goals and financial circumstances.

A few days ago, The Wall Street Journal quoted our Senior Investment Analyst Arif Karim in its reporting about Apple’s stock price decline since its recent earning call and earnings misses of its suppliers since.

Arif shared that we believe the market is adjusting its view from Apple as a company whose value is driven by iPhone unit growth to one that has a huge base of high value customers (top 20% income earning in the world) that it can create additional value for via greater service offerings (iCloud, Music, App Store, AppleCare, etc.), accessories (Watch, AirPods, Beats, even iPads), and moderate price increases – even for its high end iPhones at $1000, iPhones cost its users ~$1/day over a 3 year period, a fraction of the cost of a cup of coffee.

As of the date of the post, clients invested in Ensemble Capital Management’s core equity strategy own shares of Apple (AAPL). This company represent only a percentage of the full strategy. As a result of client-specific circumstances, individual clients may hold positions that are not part of Ensemble Capital’s core equity strategy. Ensemble is a fully discretionary advisor and may exit a portfolio position at any time without notice, in its own discretion.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

The information contained in this post represents Ensemble Capital Management’s general opinions and should not be construed as personalized or individualized investment, financial, tax, legal, or other advice. No advisor/client relationship is created by your access of this site. Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. If a security discussed in this blog entry is owned by clients invested in Ensemble Capital’s core equity strategy you will find a disclosure regarding the security held above. If reviewing this blog entry after its original post date, please refer to our current 13F filing or contact us for a current or past copy of such filing. Each quarter we file a 13F report of holdings, which discloses all of our reportable client holdings. Ensemble Capital is a discretionary investment manager and does not make “recommendations” of securities. Nothing contained within this post (including any content we link to or other 3rd party content) constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instrument. Ensemble Capital employees and related persons may hold positions or other interests in the securities mentioned herein. Employees and related persons trade for their own accounts on the basis of their personal investment goals and financial circumstances.

People try to put us down
Just because we get around
Things they do look awful cold
I hope I die before I get old
-The Who (My Generation, 1965)

One of the narratives driving stock price behavior over the last decade has been the idea that Millennials are fundamentally different from past generations and that their different preferences will drive different consumer spending patterns. This is an important concept to wrestle with because consumer spending is 70% of the US economy and where exactly consumers focus their spending can radically change the fortunes of different industries and companies.

In general, the narrative about Millennials has been mostly negative. They live with their parents, they eat too much avocado toast, they aren’t interested in growing up and so they aren’t buying cars and houses and the other trappings of adulthood. But we believe that for the most part the negative narrative is partly just older people complaining about young people the way they always do (see The Who’s My Generation, a hit song over 50 years ago) and partly a function of Millennials’ reaction to the Financial Crisis.

Much as Depression Babies had fundamentally different spending behaviors due to coming of age in the Depression of the 1930s, it is perfectly reasonable to think that those young adults who came of age in the wake of the Financial Crisis might have distinct spending patterns. Importantly, these spending pattern deviations will be strongest in the short term after a crisis and fade over time, as new life experiences are laid over the memories of the Financial Crisis.

Let’s take home ownership trends amount Millennials as an example. The chart shows the home ownership rate for the prime first time home buyer age bracket of 30-34. The dark purple line is the home ownership rate while the pink line is the percentage of that age group that has a job. Importantly, the employment graph is lagged by 5-years. Basically the chart looks at the percentage of people in this age bracket who own a home vs the percentage of those same people who have had a job for the past five years.

What we see here is that basically all of the reduction in demand to buy homes for Millennials is due to the difficulty they faced in getting a job due to entering the work force in the middle of the worst economy in a hundred years. It is easy to paint a picture of Millennials wanting to live in apartments and take Uber everywhere and not have kids and refuse to grow up. But the data suggests that this generation is just paying the price of the economic disaster they were bequeathed with. Since we know that the percentage of people in this age bracket that have a job is up considerably from where it was five years ago, it is very likely that over the next five years this age bracket will be buying homes at much higher rates than they have in recent years.

What about cars? Aren’t Millennials all childless, city dwellers who ride around in Uber? Here’s a string of quotes from a report out of University of Pennsylvanian’s Wharton business school.

“Millennials, the boomers’ children, have seemed far less interested in cars than their parents… But it turned out that the concern was largely misplaced. According to an article in Wards Auto, the weak sales were less a reflection of the generation’s attitudes toward cars and more the result of the Great Recession and the younger generation’s lack of resources… too many have mistaken the presence of millennials in cities as an indication that they prefer urban living. According to the 2016 National Association of Realtors Home Buyer and Seller Generational Trends study, a growing share of homebuyers are millennials, and more of them are purchasing single-family homes in suburbia.”

Here’s NPR with a similar take in an article titled “As Millennials Get Older, Many Are Buying SUVs To Drive To Their Suburban Homes”:

“As millennials get older — and richer — more of them are buying SUVs to drive to their suburban homes… Generationally speaking, the stereotype of millennials as urbanites falls flat when it comes to homeownership… And how are millennials navigating the suburbs? With SUVs, according to several recent studies… Millennials just might be mainstream after all.”

But wait, aren’t Millennials blowing all their money on avocado toast and frivolous travel that they document on Instagram? Whatever happened to buying tons of branded stuff to show off how successful you are like the Baby Boomers did? Well, while it might be easy to poke fun at Millennial consumption patterns, it is just as accurate to say that they are the least materialistic generation of the post war period. Avocado toast, travel and social media use seems frivolous? How about eating healthy, prioritizing experiences over stuff and spending your time engaging with your peers as well as the wider community of which you are a part?

At least we know Millennials are wasting their time playing video games right? Isn’t that solid evidence that they aren’t maturing into adults and that us older people are justified in complaining about their lack of work ethic? Well… How does spending every waking moment preparing to live and work in a digital economy sound? You think the military drone operators would be as good if they hadn’t played video games? Studies show gaming is a critical training activity for the modern military. How about surgeons who will spend their career manipulating robotic surgery tools like those produced by Intuitive Surgical? Studies show surgeons who have a history of playing three or more hours a week of video games committed 37% fewer errors and completed surgery 27% faster.

My teenagers type incredibly fast. The difference between their typing speed and mine is most noticeable on touch screens. Today, we dismiss that because we don’t take texting as a serious communication system. But as we move into a world where keyboards fade in relevance, older generations are going to be at a significant disadvantage against the younger generation. Just as corporate employees in their 60s and older tend to type slowly on a keyboard compared to Gen Xers who learned to type in school, I’m certain that as computing interfaces shift away from keyboards and mouses towards touch screens, voice and even augmented reality, us “olds” are going to suddenly realize that the time young people were spending on their phones and playing video games was actually an advanced, intensive training regime preparing them for their future jobs.

None of this is to say that the Millennial Generation will end up being clones of past generations. They are the most educated generation, many went to grad school pushing off employment until later in life and then needing to pay back student loans. That forced them to (responsibly) delay the phase of life where you get married, have kids, and buy a house, ie what is considered “growing up”. But they do have unique preferences (as all generations do). We feel certain they will eat healthier, travel more, be less interested in materialistic consumption and more interested in experiences (which they may well keep documenting on Instagram as their own version of social status signaling). A whole range of other preferences will also emerge over time as well, some positive and some negative. Some will fade as they get older and others will strengthen into defining characteristics.

As we look at the last decade of New Normal weak growth and observe the increasing rate of growth being experienced today, the key question to answer is whether the last decade was a drawn out hangover from the great recession or if something fundamental has changed. In thinking about Millennials and how their economic decisions compare to past generations, we’re solidly in the camp that people are people, their hopes and dreams and fears may change, but at the end of the day, they are striving for the same core life outcomes that past generations pursued.

The Millennial cohort saw the first decade of their working lives sidetracked by the foolish decisions of their elders. As the economy gets back on track, we expect the economic engagement of this cohort to rise considerable, creating a material tailwind to the economy from their pent up demand.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

The information contained in this post represents Ensemble Capital Management’s general opinions and should not be construed as personalized or individualized investment, financial, tax, legal, or other advice. No advisor/client relationship is created by your access of this site. Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. If a security discussed in this blog entry is owned by clients invested in Ensemble Capital’s core equity strategy you will find a disclosure regarding the security held above. If reviewing this blog entry after its original post date, please refer to our current 13F filing or contact us for a current or past copy of such filing. Each quarter we file a 13F report of holdings, which discloses all of our reportable client holdings. Ensemble Capital is a discretionary investment manager and does not make “recommendations” of securities. Nothing contained within this post (including any content we link to or other 3rd party content) constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instrument. Ensemble Capital employees and related persons may hold positions or other interests in the securities mentioned herein. Employees and related persons trade for their own accounts on the basis of their personal investment goals and financial circumstances.

On Wednesday, Ensemble Capital’s CIO Sean Stannard-Stockton was interviewed on CNBC’s Squawk Box Asia to talk about the recent market pullback, Google, Netflix and Apple. The full interview is not available online, but the segment of his interview discussing Apple is available here.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

The information contained in this post represents Ensemble Capital Management’s general opinions and should not be construed as personalized or individualized investment, financial, tax, legal, or other advice. No advisor/client relationship is created by your access of this site. Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. If a security discussed in this blog entry is owned by clients invested in Ensemble Capital’s core equity strategy you will find a disclosure regarding the security held above. If reviewing this blog entry after its original post date, please refer to our current 13F filing or contact us for a current or past copy of such filing. Each quarter we file a 13F report of holdings, which discloses all of our reportable client holdings. Ensemble Capital is a discretionary investment manager and does not make “recommendations” of securities. Nothing contained within this post (including any content we link to or other 3rd party content) constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instrument. Ensemble Capital employees and related persons may hold positions or other interests in the securities mentioned herein. Employees and related persons trade for their own accounts on the basis of their personal investment goals and financial circumstances.