We continue to be in the midst of one of the most challenging periods for investors, particularly for growth investors. It’s not just growth stocks that are down. One of last week’s headlines stated that the first half of 2022 is the worst start to stocks (S&P 500) in the past 50 years. Crypto currencies, which had enamored many, are also down more than 70% from November 2021 all-time highs. Even gold, which is supposed to be a hedge against inflation, is up only about 3% since the start of the selloff in October, and, adjusted for inflation, gold has provided a negative real return. The main point being that during the past eight and a half months it’s been very difficult for investors to make money. Holders of cash during this period have also had their purchasing power eroded by inflation by more than 0.65% per month. Even bonds which are generally considered “safer” than equities have had their worst start of any year since the 1800s! So, there have been few places to hide to earn a return let alone preserve capital.
I’m sure many/most readers of this blog have not done well in the past eight and a half months. It’s probably little consolation that most investments are down or that five years of market crushing returns more than make up for the recent drawdown. Human psychology leads us to focus more on recent change rather than a longer view. Human psychology can also lead us to make poor decisions. Finally, it’s times like these that can cause investors to become more risk averse (or even forever exit the stock market) even when the data show it’s probably not in their best financial interest. Aversion to loss is a strong phycological factor and actually enduring a large loss reinforces the urge to preserve (fear) at the expense of seeking gain (greed).
If there are silver linings, June was a positive, albeit slightly, month for the portfolio, and the S&P 500 show a negative June and lagged the portfolio for the first time since February. The portfolio ended June at -65.8% YTD while the S&P 500 ended the first half of 2022 at -20.0% YTD.
PRIOR PORTFOLIO UPDATES
PORTFOLIO PERFORMANCE
| DATE | GauchoRico Portfolio (YTD) | S&P500 Total Return (YTD) |
|---|---|---|
| Jan22 | -31.7% | -5.2% |
| Feb22 | -32.6% | -8.0% |
| Mar22 | -35.1% | -4.6% |
| Apr22 | -49.6% | -12.9% |
| May22 | -66.5% | -12.8% |
| Jun22 | -65.8% | -20.0% |
Weekly Performance
| DATE | GauchoRico YTD | S&P500 TOTAL RETURN YTD | DELTA |
|---|---|---|---|
| 01/07/22 | -24.1% | -1.8% | -22.2% |
| 01/14/22 | -30.5% | -2.1% | -28.4% |
| 01/21/22 | -39.5% | -7.7% | -31.8% |
| 01/28/22 | -39.3% | -6.9% | -32.3% |
| 02/04/22 | -33.6% | -5.5% | -28.2% |
| 02/11/22 | -25.2% | -7.2% | -18.0% |
| 02/18/22 | -33.0% | -8.6% | -24.4% |
| 02/25/22 | -35.8% | -7.8% | -28.0% |
| 03/04/22 | -42.4% | -8.9% | -33.5% |
| 03/11/22 | -48.4% | -11.5% | -36.9% |
| 03/18/22 | -37.9% | -6.1% | -31.8% |
| 03/25/22 | -37.6% | -4.3% | -33.3% |
| 04/01/22 | -33.7% | -4.3% | -29.4% |
| 04/08/22 | -41.6% | -5.5% | -36.1% |
| 04/15/22 | -40.8% | -7.5% | -33.3% |
| 04/22/22 | -49.0% | -10.0% | -39.0% |
| 04/29/22 | -49.6% | -12.9% | -36.7% |
| 05/06/22 | -58.6% | -13.1% | -45.5% |
| 05/13/22 | -62.4% | -15.1% | -47.3% |
| 05/20/22 | -67.0% | -17.7% | -49.3% |
| 05/27/22 | -64.9% | -12.2% | -52.6% |
| 06/03/22 | -64.7% | -13.2% | -51.4% |
| 06/10/22 | -66.4% | -17.6% | -48.8% |
| 06/17/22 | -68.8% | -22.3% | -46.5% |
| 06/24/22 | -61.8% | -17.3% | -44.5% |
| 07/01/22 | -63.9% | -19.1% | -44.8% |
ALLOCATIONS
| TICKER | 7/1/22 | 6/30/22 | 5/31/22 | 4/30/22 | 3/31/22 | 3/18/22 | 2/28/22 | 1/31/22 | 12/31/21 |
|---|---|---|---|---|---|---|---|---|---|
| DDOG | 40.8%** | 40.4%** | 41.4%** | 39.4% | 33.4% | 33.4% | 35.7% | 36.8% | 31.7%* |
| CRWD | 23.3%** | 23.9%** | 23.8%** | 21.9%** | 15.4% | 14.1%* | 8.3%* | 6.4%* | 5.9%* |
| SNOW | 23.0%** | 23.3%** | 21.8%** | 12.8%** | 9.8%** | 10.0%** | 18.1%** | 18.4%** | 15.5%** |
| NET | 3.7% | 3.7% | 4.9% | 4.4% | 4.2% | 4.0% | 3.9% | 3.2% | — |
| UPST | 0.1%* | 0.1%* | 0.2%* | 2.7%* | 3.0%* | 3.7%* | 4.6%* | 3.5%* | 14.7%* |
| ZS | — | 4.5% | 4.7% | 22.5%* | 16.9%* | 16.0%* | 16.2%* | 12.6%* | 4.3%* |
| S | — | — | 6.8% | 6.3% | 4.9% | 5.4% | 5.1% | — | — |
| MNDY | — | — | — | 3.5%^ | 9.4%^ | 10.5%^ | 9.1%^ | 26.0%^ | 27.5%^ |
| AFRM | — | — | — | — | — | — | — | 3.8% | 7.4% |
| Cash | 9.1% | 4.0% | -3.7% | -7.3% | 6.2% | 6.8% | 2.3% | -5.6% | -4.0% |
The allocation details described below are as of the end of June. Four of the six positions in the portfolio are leveraged with long-term call options. CRWD: of the 23.9% allocation, 21.1% are shares and 2.8% are Jan2024 $180 and $200 calls. DDOG: of the 40.4% allocation, 38.7% are shares and 1.8% are Jan2024 $120 calls. SNOW: of the 23.3% allocation, 22.6% are shares and 0.7% are Jan2024 $300 calls. UPST: of the 0.1% allocation, 0.1% are shares and a negligible amount are Jan2023 $330 calls. Note: there are some rounding errors in the preceding shares/call options splits. The portfolio is comprised of 5.3% in long call options, 97.9% in shares, 4% cash, and 0% in short put options. On 1 Jul, I sold my ZS position and did not reallocate the proceeds into any new or existing position.
I’d like to address the elephant in the room: I’ve allowed my portfolio to become extremely concentrated. While the degree of concentration appears higher than it’s ever been, the percentage of my net worth held outside of my portfolio exceeds now 50%; two years ago the portfolio comprised greater than 95% of my net worth. The main point here is that while the allocation percentages appear higher than ever, the majority of my assets are now outside the stock portfolio. Therefore, a 40% allocation today would be equivalent to a <20% allocation two years ago. Nevertheless, I do realize that holding a four-stock portfolio with three oversized positions comes with additional firm-specific risk that I will eventually want to mitigate.
So, why haven’t I spread out the risk more? Over the course of 2022, my criteria for holding a position have become more stringent because the overall business environment (e.g. high inflation, higher cost of capital, decreased access to capital, decreased globalization, more negative outlook for economic growth) has deteriorated. Last Summer, I wrote a post about the important characteristics of growth companies. I still rely on these criteria to select companies for my portfolio, but, given the additional risks in today’s environment and the uncertainty about the future, I’ve chosen to place increased emphasis on cash flow/profitability. As a result, during 2022, I’ve either eliminated or radically reduced positions which I believe could be at increased risk of running out of capital or never becoming profitable. In times of economic stress, the strong tend to become stronger. The affected positions include AFRM, UPST, MNDY, and S. While UPST is profitable, I’ve increasingly lost confidence that the Company’s AI underwriting method will be widely accepted and adopted. Thus, as I’ve cut positions, I’ve tended to pay down margin and then increase cash in lieu of further adding to my three high conviction positions (DDOG, CRWD, SNOW). I’ve also avoided adding new positions just for the sake of diversification. I’ve looked at MDB, BILL, and some others but have remained either unconvinced regarding their future growth or unimpressed by their demonstration of operating leverage. Thus, I’ve concluded that only DDOG, CRWD, and SNOW are demonstrating the combination of business strength, industry dominance, strong and increasing cash flow generation, and operating leverage. In addition, these companies are still riding the secular trends digital transformation and cloud adoption which are still relatively early in their adoption cycle.
I’ve also contemplated adding positions outside of IT software industry but concluded that the positions that I already own are more likely to rebound the strongest once the stock market reverses its downward trend. Companies in other sectors and more mature companies in IT software (e.g. CRM) have sold off much less than my portfolio companies; I would expect these other companies’ stocks to grow more slowly than those that I own. However, I do believe that stock selection will turn out to be very important because not all SaaS companies will perform well going forward. Ultimately, success in the stock market eventually comes down to the business success and performance of the underlying companies.
PORTFOLIO CHANGES
Changes since 31May 2022
- S: Sold entire position after earnings.
- ZS: Sold entire of remaining position on 1Jul.
- CRWD: Deleveraged and trimmed a small amount of CRWD on stock price strength.
PORTFOLIO COMPANY UPDATES
S and CRWD reported their Q1 2023 results in the beginning of June. Both companies went into their earnings calls under the backdrop of very strong tailwinds for cyber security so my expectations were very high especially in light of PANW’s record billings metric.
S (Q1 FY2023 reported on 1Jun):
Last year, I had concerns about S as an investment and I did not invest in the Company until February 2022. To summarize my concerns, they had included 1) large and growing losses and 2) participation in a competitive space with well resourced competitors (i.e. CRWD and PANW). I have also questioned whether S’s competitive advantage of automated threat remediation would be sustainable given the vast resources of CRWD. This is still TBD. Furthermore, CRWD could easily outspend S to make S’s customer acquisition more difficult and more costly. All of these concerns remain today, and the environment has shifted making it more difficult for unprofitable companies to operate due to less access to capital which has also become more expensive. S delivered another quarter of solid hyper growth at +109% y/y, but losses continued to expand. While S still has plenty of cash, I’ve always questioned whether they have enough fuel to reach orbit (i.e. profitability). This is a concern not afflicting CRWD because CRWD prints its own cash and is therefore in control of its own destiny regardless of how long it remains difficult to raise new capital. CRWD can now more easily take advantage by leaning into growth by spending more and by continuing to make other strategic investments (e.g. acquisitions) when opportunities arise. S’s management was unclear about guidance and growth during the earnings call. It was difficult for me to understand at which points the numbers included revenue/forecasts for their acquired companies. I expect my portfolio companies to be clear and concise, and a failure to do so only further reduces my confidence.
CRWD (Q1 FY2023 reported on 2Jun):
CRWD’s Q1 did not disappoint. Growth remained within range of steady at 61.1% y/y growth. The other key performance indicators (KPIs) were all solid with no yellow or red flags. Any weakness would have been met with concern because cyber security in general is showing such strength. CRWD is now a scaled company with 32% free cash flow margins and FCF growing at 34%. Yes, CRWD has hit its long-term operating model, and it’s still growing the top line at >60%. CRWD continues to invest heavily into future growth; in fact, management stated on the call that the Company intends to continue heavy investment into growth. With its cash war chest growing every quarter, CRWD will have no problem making good on this promise.
ZS:
I wrote my thoughts about ZS in the 31May portfolio update. After further consideration particularly after seeing CRWD’s and S’s strong results, I decided that ZS’s results were inferior and less than I expected. I do not need ZS as a position in the portfolio when I already have a large position in CRWD. ZS may pull through with more government business in the coming quarters, but I saw enough yellow flags to eliminate the remainder of my position.
FINAL THOUGHTS
Since 2009 there has been one thing to worry about after another. Every few months there was some crisis, yet stocks continued to march higher despite some temporary pullbacks. Central banks were mostly accommodative during this period. The pullback from this accommodation is probably the biggest change affecting us today. From my perspective, there seem to be too many moving parts and uncertainties to figure anything out on a macro level, but I do have concerns. However, I’m continuing to ride through the storm, hanging on to those companies which continue to perform while possessing the financial strength to endure. Now that multiples of high growth companies have dramatically contracted, I prefer to stay invested in those hyper growers that I believe will show continued business strength and enhance their competitive positions. At some point, I anticipate a healthy rebound in the hyper growers that have (and continue) to show durability. My extreme portfolio concentration adds some risk, and I don’t consider it to be sustainable for me over the long-term. I expect that my mindset will shift increasingly from aggressive growth to capital preservation as the tide turns and growth comes back in favor. Of course, I don’t know whether this will take months or years so I plan to maintain a healthy cash balance to continue to ride through. In the coming weeks, we will get another earnings cycle and the necessary datapoints to make any portfolio modifications. I expect to write my next portfolio update after my companies have reported their next results.
The opinions, thoughts, analyses, stock selections, portfolio allocations, and other content is freely shared by GauchoRico. This information should not be taken as recommendations or advice. GauchoRico does not make recommendations and does not offer financial advice. Each person/investor is responsible for making and owning their own decisions, financial and otherwise.