Thank you for your continued trust and support; you are the best partners I could ask for.
As I reflect more on the past year, the more it becomes clear that the core tension in the art of investing is balancing humility and conviction. When a stock goes against you, do you double down, sit still, or cut it? How do you know you’re right? What if you’re wrong? But if you let the stock price do your thinking for you, that is a recipe for terrible results, especially if you think you’re a long-term investor. If you study traders, you’ll see that price is the only thing that matters. If the price is down, they’re out of the position. But if you think you’re a long-term investor and act like a trader, you will almost surely lose money. So it’s important to know what game you’re playing. To be crystal clear, we are playing the long-term game. However, sometimes I find myself using the amorphous “long-term” to absolve myself of responsibility. The key question here is: how do you know you’re wrong?
It can actually be quite tricky because it depends on your time horizon. The trader will know they’re wrong when the stock hits their stop loss and kicks them out. But the answer is foggier for investors because time horizons can be different. If we drill further, the next question becomes: how long is long-term? There’s not a single answer here but I know it’s longer than one year but if your stock pick is still down after ten years, you might be wrong. After a decade, even if you paid a premium multiple, earnings growth should bring the multiple down. So the answer to balance the tension between knowing whether you’re wrong and how long is considered long-term is likely between one and ten years. Wow, so much clarity, right? (*sarcastic*). For myself, it’s somewhere between 3-5 years. If, after 3 years, the stock still hasn’t gone anywhere, it’s quite likely that I paid too high of a price or I didn’t properly assess the economic characteristics of the business. For example, if you paid 40x earnings, three years of 20% earnings growth would bring that multiple down to 23x. However, if you paid 40x earnings and there was no growth after three years and the multiple contracted to 23x, that’s more than a 40% loss. It’s all about earnings growth and the earnings multiple.
The harsh reality is that there are very few opportunities that meet these two criteria of fast earnings growth and a low multiple. That’s why our portfolio is concentrated. We put all 839 companies in our research database through an 18-point checklist and only four companies scored a three or lower (lower is better). However, the lowest free cash flow multiple of the four is 45x so there is a tradeoff between expected earnings growth and starting multiple. Another 19 companies scored a four on the checklist system. So out of 839 companies, only 23 scored lower than five. This is the pool we vigorously track and wait for reasonable multiples. As I look over our past mistakes, almost every one is a compromise on business quality rather than buying at too high of a multiple. That’s why we try to keep our standards ridiculously high and then wait for prices that meet our hurdle rate. It’s simple but not very easy because when a company sells-off, there is typically a reason for it. And it’s our job to determine whether or not the perceived risk is as real as the market is making it out to be.
With that as a preface, I wanted to switch up the format a little bit. For the last four quarterly letters, the format has been a discussion on the philosophy of the fund and then a deep dive into a company. As the philosophy has crystallized, I thought it would be nice to provide a quick blurb on the companies in the portfolio to give you a better sense of where your dollars are parked. So let’s not waste another moment!
The company has a dominant position selling hardware and software to police officers. Its new Taser 10 and Axon Body 4 will provide a top-line boost as the company continues to grow its recurring revenue business. With a visionary founder at the helm and plenty of runway left, the stock has never been cheap. That said, I see this company having the potential to do $10 billion in revenue one day as the international piece of the business develops and the company’s optionality kicks in through further products such as Axon Records and Justice Premiere. At 30% steady-state margins, it’s quite possible the company could do $3 billion in free cash flow one day. At 25x, that’s a $75 billion company, over 4x from today’s prices. I believe that will happen in 10 years, which would be a 15% CAGR, without adding back any cash accumulation.
2. Nu Holdings
The company is the dominant mobile bank in Brazil. With over 90 million users, Nubank is a household name and is still growing quite fast. It’s the 4th largest financial institution by users in Brazil and they are taking lots of market share in the credit card business, while also becoming increasingly sticky through new products like payroll lending. The management team is top notch, led by highly incentivized founder, David Velez and the company is expanding into Mexico and Colombia, hoping to get to Brazil-levels of penetration one day. At 200 million users and $100 in revenue per user, I think the company could easily get to $20 billion in revenue one day. At 30% banking margins, that’s $6 billion in earnings. Using a 15x multiple, that leaves us with $90 billion in market value. I believe that is doable in 7 years, leaving us with a 17% CAGR.
We’re going to stay in South America, as we move to MercadoLibre. The company is most well known for its dominant position in Latin American e-commerce. As an aside, notice that for each of these companies I used the word “dominant”. We look for fast-growing, profitable, founder led companies with dominant market positions. And MercadoLibre fits the bill. While there are often competitive concerns about Amazon and Shopee, both companies are retrenching to focus on profitability and competing with MELI is likely not the wisest use of dollars. Meanwhile, MELI will continue to invest in logistics and payments infrastructure, strengthening its flywheel. The company trades for about 25x forward EBIT which I don’t think is that crazy considering the company has grown at a 50% CAGR over the past 7 years.
4. Shelly Group
This is a Bulgarian home automation company. Random, I know! But the growth and profitability are certainly something that caught my attention. Shelly Group recently changed its name from Allterco to focus on the main business line, Shelly. These are electrical relays that connect to appliances, lights, fixtures, etc. to enable home automation. The ease of use and interoperability have led to the company’s growth. It’s a seamless, inexpensive way to do home automation. The company forecasts greater than 40% annual growth for the next three years, expanding its EBIT margins to 30%. At that point, I could easily see the company doing $60 million in EBIT. At 15x earnings, that’s a 26% CAGR in roughly three and a half years. Meanwhile, the two co-founders each own more than 25% of the business and the products just keep improving. The company has a DTC sales channel through Amazon, Walmart and other retailers but the rest of the business that is sold through installers will likely continue to be a huge tailwind.
This is the newest addition to the portfolio and it differs slightly from the typical company that we invest in because it’s not founder led nor is it a market share leader. However, CEO John Fieldly has overseen nearly all of Celsius’s success and the company is rapidly gaining share against incumbents. If you’re not familiar with Celsius, it’s a fast-growing energy drink that has a positioning advantage as the “healthy” option compared to Monster and Red Bull. The company has grown sales from $50 million to $1.3 billion in just five years. And more recently, Celsius’s exclusive distribution relationship with Pepsi has strengthened its competitive advantage. The quick thesis is that Celsius’s market is likely wider than the incumbents because it resonates with both men and women while Monster and Red Bull, collectively, do 9x more in sales in the US. However, Celsius is already ahead of Monster and Red Bull in sales on Amazon. If that’s a hint at the future, it’s possible that Celsius could rival incumbent sales in five or so years. Even at $5 billion in revenue at 30% margins, that gives us $1.5 billion in earnings. At 20x earnings, that’s about a 20% CAGR from today’s price. While it’s not a guarantee that Celsius becomes the leader, it definitely has a counter-positioning advantage and plenty of growth opportunities, as the company has barely scratched the international opportunity. At the same time, we must monitor this investment closely because the barriers to entry are fairly low and there is quite a bit of competition.
While Tesla is a $750 billion company, I still think it has plenty of growth in the tank. The company’s long-term goal is 20 million cars, which could yield more than $800 billion in revenue (the next gen model will be important to reach this volume). Further, its energy business is hitting an inflection point on profitability and while we’re at sort of an in-between point as far as autonomy goes, it’s an extremely attractive call option. As Elon has mentioned, the upgrade to actual full self-driving would be the single biggest instant value creation of all time. While Mr. Musk is often given to hyperbole, I’m with him on this one. And looking out even further, which is far more uncertain, the other bets like Optimus and Dojo do seem to indicate the company has a lead in real-world AI.
But even if we just take the car business without FSD, $800 billion in 2032 revenue could give us $120 billion in profits. Using a simple 20x earnings, we get a $2.4 trillion company. That’s still a 16% CAGR without including all of the other long-term bets that will likely provide some value creation, if the company’s past is any indication of the future. Call me crazy but I think there is a real path to Tesla becoming the most valuable company on the planet. There will be bumps as more competition continues to come into the market but Tesla really is playing a different game. The sheer amount of data that the company has already collected and the millions of incremental cars that will be added annually to that treasure trove is an advantage that should not be overlooked. True autonomous driving is still a bit away but I don’t think that’s completely necessary to the thesis. If it does materialize, this can be a $5 trillion company over the next decade. I’ll take those odds as the company continues to innovate, lower prices, and attract some of the world’s most ambitious engineers.
I’d like to point out the obvious before wrapping up which is the delta in the performance of the portfolio versus the underlying companies. The main reason for this is that we started the year off more diversified so these big winners were smaller positions and the rest of the portfolio dramatically underperformed as we were heavily positioned with small-mid cap companies like IDT, Sanara Medtech, Inspire Medical, and Xpel. As we reflected on the underperformance, it led us to focus maniacally on our very best ideas. The result is the current portfolio of just six companies.
Each one of the six has strong management teams with huge and growing reinvestment opportunities. Each one is also free cash flow positive and GAAP profitable with great competitive positions in their respective industries. The slowest grower is Tesla and each business has a very strong balance sheet as none of them even have net debt. I’m happy to let time do its thing, allowing these companies to serve more customers and continually add more value. And one last note on the portfolio – we did actually sell Snowflake as the valuation ramped up. At $70 billion, the stock will have to trade at 14x sales by 2029 to get a 15% CAGR. Considering 25% free cash flow margins, that’s betting on more than a 50x earnings multiple 5 years out to double our money. It fits the criteria for growth and quality but the current valuation is a little rich for our blood.
Moving on to some housekeeping – for the indefinite future, we are stopping any focus on fundraising, but rather concentrating solely on research and the portfolio. If you know someone who would be interested in becoming an LP, they can reach out to get on the waitlist so we can notify them when we reopen.
I’m honored to have you as a partner. Thank you for your trust and support. It enables me to think long-term and will be our own competitive advantage.
The stock market, like life, will have its ups and downs. All we can do is focus on what we can control and work hard to continually raise our standards. Our strategy is simple – hitch a ride to the world’s best entrepreneurs that are running the fastest-growing, highest-quality companies at the most attractive valuations we can find. Here’s to many more years of focusing on the inputs and letting the outputs take care of themselves.
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