Poaching From Ark Invest: Innovative Disruption For Value Investors
- Value investors who want to supercharge their portfolios with disruptive growth technologies can steal ideas from Cathie Wood's Ark Invest.
- Baidu and Teradyne are two of the most promising ARKK holdings with a trifecta of lucrative growth potential, reasonable valuation, and stable history of profits.
- Square is a great fintech company that is primed to disrupt big banking, but the nosebleed valuation makes it a precarious investment.
- For value investors who want to get in on electric and autonomous vehicle tech, GM is a better bet than Tesla.
With the S&P at all-time highs, $60,000 bitcoin, Tesla (TSLA) at $650B market cap, and pre-revenue companies like Virgin Galactic (SPCE) trading at 3x their debut price, this market has not been a friendly environment for value investors of the traditional Graham-Buffett school. Some believe it's only a matter of time before the growth bubble pops and value investors have their day again, but in the meantime, there's money to be made.
It doesn't matter what we think the market should be, only what it is: the million dollar question is, how to profit? One strategy that I've been experimenting with is to consider the ideas of talented stock pickers of a diametrically-opposed discipline, and find where those picks intersect with my own style.
The idea is something like this: identify good companies that exist in the overlap between growth and value, stocks trading at reasonable valuations with stable revenue and earnings, but with imbedded call options for disruptive growth potential waiting to be triggered. Basically, GARP, but supercharged with high tech and cool science.
Maybe the fund manager who most represents the polar opposite of value investing in 2021 is Cathie Wood of Ark Invest, who needs no introduction (Etsy sells t-shirts with her face on it). Many value investors attribute her staggering success to dumb luck, but I maintain a neutral position: alpha is alpha. While her growth-at-any-price investment style diverges drastically from my own, I respect her a great deal and see her as an extremely intelligent investor who not only invests in innovative companies, but is bringing something very innovative herself to the world of finance and shaking things up in a really fascinating way, from popularizing low fee actively managed ETFs to hiring "rocket scientists" and training them to be financial analysts. In other words, someone worth stealing from.
A quick browse of her flagship ARK Innovation Fund (ARKK) will reveal that most of its holdings are anathema to value investors (they don't even have Price/Earnings ratios!). Two look promising: they were hand selected by Wood, who currently has an unsurpassed track record for picking winners in new disruptive technologies, but they also trade below the average P/E of the S&P 500 with a stable history of profits. These two are Baidu (BIDU) and Teradyne (TER).
I'm already familiar with Baidu, I bought to open last year when it hit $105 and continue to hold an extremely large position in it. Wood has always been bullish on China, and she identifies Baidu as her highest conviction pick amongst Chinese equities. When I purchased Baidu, investors were very bearish on it: its core Internet search business was struggling, besieged by social media newcomer ByteDance (BDNCE) and the rise of Douyin/TikTok, a situation that was exacerbated by Baidu's heavy investment in R&D which was crushing its operating margins.
I believed that with effective cost controls, it could return its search business back to profitability, and for the rest of its nascent ventures in artificial intelligence and autonomous driving, I considered these to be call options for extra alpha. One year later, Baidu has indeed returned to profitability, and the call options are also beginning to pay off: recently, Baidu announced a new partnership with Geely (OTCPK:GELYF) to form a joint venture to build smart electric vehicles, with Baidu taking majority stake and voting power.
More importantly, they have the backing of the Chinese government, as the only company allowed to conduct driverless road tests in Beijing. I can see why Wood likes the stock, they are heavily invested in innovative technologies that have a high probability of paying handsome dividends in the near future, but I believe Baidu simultaneously fits the profile of a value stock, with a near-monopolistic cash cow business in their Internet search that is funding all these ambitious projects.
The risk of Chinese delisting is way overblown, it was a Trump administration initiative that will not necessarily materialize under Biden and even if it does happen, a Chinese blue chip like Baidu would barely be affected (Tencent (OTCPK:TCEHY) trades OTC with no problems).
Teradyne was a new one for me and Ark Invest put it on my radar. Their business seems sound, if a bit cyclical. As a testing solutions provider for semiconductors, hard drives, and wireless systems, they appear to be on the right side of multiple high velocity macro trends: robotics (including autonomous vehicles), industrial automation (see Tesla's Gigafactory 3 and Amazon's warehouse robots), 5G technology + increasingly sophisticated mobile devices which will require more extensive quality control.
They're trying to expand into industrial robotics with a modest amount of success in recent years to diversify their revenues. Financials are solid, with operating income almost doubling YOY, balance sheet is clean with $1.4 billion in cash and marketable securities versus $376 million in debt, valuation is reasonable at 30x trailing earnings. CEO is a lifer who started with the company right out of college. There's a lot to like about Teradyne, and personally I'm sold, recently initiating a moderate-sized position at $130.
Of Cathie Wood's cash burning companies, the one I like the most is Square (SQ). Wood gave a fintech presentation at Exponential Finance South Africa back in 2019 where she touched on the stock along with competitor PayPal (PYPL). Right now I believe Square to be the single biggest threat to traditional finance institutions and big banking. They're building a tremendous bidirectional ecosystem both on the vendor side with their point-of-sale technology and on the consumer side with Cash App.
China has already reached critical mass in terms of app facilitated monetary transactions, but if the US ever gets to the point where it's post-cash and post-card, I would bet on Square being the one to take us there. That being said, valuation-wise Square is a hard one to swallow for value investors. Their operating revenues are actually functionally overstated because of how they record bitcoin transaction revenues from Cash App, at my last look their true P/S ex-bitcoin was about twice as high as the face value.
Zillow (Z) had the same problem when they decided to enter the house flipping business, where a shift in accounting methods led to an apparently huge YOY increase in revenue when the core business only grew in the mid-single digits. Also, I'm a bit iffy on Square's fiscal management, I honestly don't see any value add from their recent moves to buy bitcoin with company assets. Regarding Square, I'll be staying on the sidelines for now, but keeping an eye on it, because I do think it is a promising business with a bright future.
General Motors: Bullish
Wood is famous for her prescient calls on Tesla and her roaring bullish outlook on EVs, but the horse I chose to back in the EV race is General Motors (GM). GM just unveiled the all-electric Chevy Silverado using their Ultium battery technology with a range of 400 miles a couple of days ago. Cruise is at the forefront of AV development and in my opinion properly strategically focused on ride-sharing with the Origin rather than personal vehicles (also being developed at Factory ZERO with the electric Silverado).
Management is fiscally disciplined with a hyper-emphasis on return on invested capital. There are definitely risks involved, particularly on the GM Financial side with the possibility of widespread auto loan delinquencies, but at $27/share last year, GM presented far too asymmetrical a reward/risk profile for me to ignore, and even now, with share price having advanced over 100%, I am holding because I still think it has great potential to capture outsized returns.
EVs and AVs will turn the auto industry upside down, and I agree with Wood that Tesla is likely to be a big winner, but it won't be the only one - of the traditional auto manufacturers, I think GM is the one best prepared to give Tesla a run for its money, and at a fraction of the valuation.
I am a big supporter of the eclectic approach in investing as well as in other disciplines, maybe more so than simple contrarianism. The research shows that value can work, growth can work, even momentum can work. As investors we would naturally gravitate towards one style based on our own disposition, but it may be helpful to generate ideas by finding the overlap with an opposing style, so there are multiple pathways to alpha. Even investors who have full faith in Ms. Wood's stockpicking talents and invest directly in one of her innovation funds (ARKK) (ARKQ) (ARKW) (ARKG) (ARKF) (ARKX) may benefit from closely scrutinizing her holdings for individual opportunities.
Ark's assets under management grew from $3.6 billion to $50 billion last year. No matter how good Cathie Wood may be, the size of her funds works against her ambition to beat the broader market, she no longer has the ability to be as nimble as she once was when her AUM was much smaller and liquidity was less of a concern. Private investors do not have such constraints (unless Jeff Bezos is reading this, in which case hi!), and passing Wood's picks through the filter of your own investment strategy may be a legitimate way to produce even better results.
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Analyst’s Disclosure: I am/we are long BIDU, GM, TER. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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