The time has come for the year-end review of our model portfolio, a collection of 15 stocks that we selected in January as our core investments for 2021. The chart above illustrates the torrid time the last quarter has been for growth stocks and our model portfolio. As growth investors, you get somewhat accustomed to volatility but this year has been especially turbulent as investor sentiment swung back and forth due to a series of world events. This was the year to be an index investor as the S&P steadily climbed and ended the year up almost 30%.
At the end of Q3, only 8 of the 15 stocks were showing positive returns but as we near the end of the final quarter, only 4 are showing positive returns and the portfolio as a whole is showing a negative return. While the model portfolio has underperformed in its year of inception, as long-term investors, we are prepared to give it time as the investment thesis for most of the stocks remains intact.
In today’s episode, we look at each of the stocks and discuss some of the key stories.
- Shopify (SHOP) has ended the year with a healthy gain after cementing its position in facilitating e-commerce around the world and has recently announced a partnership with GigLabs to enable minting, trading, and holding of non-fungible tokens (NFTs).
- MercadoLibre’s (MELI) business continues to expand but the stock has stalled this year and took a tumble in the last quarter possibly triggered by a secondary stock offering and inflation fears in its key markets in Latin America.
- Sea Limited (SE) was flying high through most of the year, but slowing growth in its Garena gaming division has concerned investors leading to a sharp sell-off in Q4, as profits from the Garena division support growth in the other divisions, Shopee and SeaMoney.
- Square (SQ) has had an eventful year including acquisitions of Tidal and AfterPay, and more recently its CEO, Jack Dorsey has gone full-time and the company has changed its name to Block, possibly signaling an increased focus on the blockchain.
- Guardant Health (GH) work on liquid biopsies continues and they recently announced that they have reached the enrolment target for their ECLIPSE study to evaluate their LUNAR-2 blood test to detect colorectal cancer in average-risk adults, which will support a premarket approval application if a positive outcome is seen.
- Editas Medicine (EDIT) is working on gene therapies using CRISPR-Cas9 and their primary drug candidate, EDIT-101, treats LCA-10, a genetic disease that causes blindness. Recent results from ongoing clinical trials have shown good safety but limited efficacy at the test dosage, paving the way for continued trials.
- Intuitive Surgical (ISRG) is one of the winners in the model portfolio and recently announced that over 10 million procedures have been performed using their robotic surgical systems, highlighting the data advantage the company has to help it refine and advance the field of surgery for years to come.
- Teladoc Health’s (TDOC) share price continued to decline to keep it as the worst-performing stock in the model portfolio, as the expensive Livongo acquisition from the previous and lack of customer growth this year continue to drag. Teladoc remains a leader in telehealth, which is expected to grow globally at a CAGR of 26% until 2030.
- Crowdstrike’s (CRWD) endpoint protection platform, Falcon, is needed more than ever to protect corporate devices and networks from cybersecurity breaches, which was highlighted recently by the discovery of a vulnerability in the widely used Log4J software.
- Cloudflare (NET) continues to announce new products and to expand its total addressable market, including the cybersecurity space. It was the best-performing stock in the portfolio with a market-beating return of 86% YTD.
- Twilio (TWLO) stock has been held back by slowing growth and increasing losses coming out of their latest earnings release. Margins should improve if software-based products such as Segment, Flex, Frontline, and Engage can scale. This is another case of growth being pulled forward by the pandemic leading to difficult YoY comparisons.
- Fiverr’s (FVRR) stock has suffered in the second half of the year but they continue to support the freelancer community with a new offering called subscriptions that helps freelancers form long-term relationships with clients and also a partnership with Stride Health to give access to affordable health insurance.
- Disney’s (DIS) theme park, cruise line, and movie businesses are still hindered by the ongoing pandemic and its flagship streaming service, Disney+, has started to show signs of slowing growth after a strong start 2 years ago. However, the company has returned to profitability this year and remains well-positioned for both home and out-of-home entertainment.
- Magnite (MGNI), the leading supply-side programmatic ad platform, continues to slide following a promising Q1 and recently announced a share repurchase program to run over the next 12 months. While only amounting to about 2% of the shares, a stock buyback by such a new and small company raises questions over whether the money could be better used to grow the business instead.
- DocuSign (DOCU) CEO, Daniel Springer, said in the latest earnings call that after 6 quarters of accelerated growth, customers are returning to more normalized buying patterns. This was enough to send the stock down over 40% erasing gains achieved year-to-date. DocuSign commands over 70% of the e-signature market, the gateway to its Agreement Cloud suite of services for CLM, and still expects to grow revenues 39% YoY for the full year.
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Transcript
Luke: Hi, this is Luke.
Albert: This is Albert.
Luke: Today is Tuesday the 28th of December.
Albert: Welcome to the Telescope Investing podcast.
Intro
Luke: Alb, it truly is year-end and the episode we’ve been dreading for at least the last three months. It’s the review of the whole year model portfolio, our 15 stocks covering eight megatrends that were designed to beat the market in 2021.
Albert: You’re right, Luke, I have been dreading this. We started tracking this portfolio from the 27th of January of this year. And it did really well the first month or so smashing the index. But since then it’s been a rocky ride and now it’s dropped a lot in the last few months.
Luke: This last quarter has been absolutely disastrous for growth investors and disastrous for our model portfolio. The performance numbers are based on the closing prices as of yesterday, Monday, the 27th of December. We were going to wait until year-end, but we didn’t want to skip a week of the podcast, so you’re getting today’s episode a little bit early.
Albert: So there are three days left in the year, so the market could recover and change things dramatically. But I think we’re safe in saying that we are where we are.
Luke: Yeah, it’s a bit of a shit show. We apologize to any of our listeners who’ve invested along with the model portfolio, but there is a bit of a saving grace that we’ll pick up at the end of the episode.
Albert: As a reminder, these are our core investments for the year. So this model portfolio is a big part of both our personal portfolios. And we had aimed to have at least 2% of our portfolios in each stock in the model portfolio. And I have to admit, I didn’t quite achieve that for some of these stocks and even worse, some of them were above 2%, but have since dipped below that due to share price action.
Luke: Yeah, you’re right. These stocks are our core investments in our own personal portfolios. And we’ve taken a battering. We’ve actually done a little better than the model portfolio, and we’re both in the black by single digits, but it’s just been a tough year for anyone who’s a growth investor.
New year resolutions
Luke: Anyway, before we get into the horror show, any new year resolutions for 2022, Albert?
Albert: Uh, I don’t really do new year’s resolutions because most people just give up within the first week. But I do set myself a couple of main goals depending on where I am in a year. Building Telescope Investing is in there somewhere, but last year, my main goal was to complete my nutrition degree, which is now done, so this year I need to find something new. I think I’ll give more time to Toastmasters and complete one of their training tracks. And if you’re not aware of Toastmasters, Toastmasters is a global network of clubs for developing public speaking and leadership skills. What about you, Luke, what are your resolutions?
Luke: I guess I should. Yeah, go on. I guess I should commit to this publicly. I’ve had a friend, Ali badgering me to do something called the four by four by 48 challenge with him. You heard of that?
Albert: I haven’t, Luke. It sounds like some sort of physical challenge?
Luke: I think it was developed by this guy, a retired US Navy Seal, a guy called Dave Goggins. It sounds simple on paper, but in practice, I think it’s probably going to be hell. You’re supposed to run four miles every four hours for 48 hours. So basically you do a four-mile run, so that’s six and a half K, and then you’ve got the rest of that four hours to rest, either sleep or eat. And you do that 12 times continuously for a long weekend. And I’ve done a marathon and I do a bunch of running regularly, but this could be an interesting endurance challenge. So Ali’s got us in the diary to do it as part of a global challenge that this guy, Dave Goggins is organizing at the start of March, so that’s going to be my focus for the next quarter I think.
Albert: I don’t know Ali very well and don’t take this the wrong way, but you’re no spring chicken. Are you sure you can handle this?
Luke: Well, you know, the greatest runners in the world are old men. And I think, old women closely behind them. I think running is a mental rather than physical endurance thing. And I’m pretty mentally tough. So let’s see!
Albert: I agree Luke, you’ve done this podcast with me for over a year and a half, so you’re definitely mentally tough.
Luke: Well, it’s made much easier by your excellent Toastmasters training, at least in the last eight or nine months.
Portfolio overview
Albert: Anyway, let’s get to our model portfolio and let’s start with a review of the portfolio as a whole. I’ll start with some good news, at the end of Q3, the portfolio was up 5% for the year, which was still quite far behind the S&P, which was up 14.8% at the end of Q3. But how about Q4? What’s happened in Q4, Luke?
Luke: Yeah. It’s not been pretty has it? By year-end, we are down 12.1% year to date. And the S&P is up a record 27.7%. So we have underperformed by what, 40%. That is material.
Albert: I can hardly believe the S&P is up almost 30% for the year.
Luke: And if you look at the graph of our relative performance against the S&P, it tells a really horrifying story, and we’ll post this on the website when the episode goes live tomorrow. The drop-off has been precipitous in this final quarter of the year.
Albert: I wouldn’t use the word horrifying, but it is very interesting. It demonstrates the relative volatility of growth stocks compared to something like the S&P 500. You expect the S&P 500 to gradually go up, as it’s an average of all the stocks in the market so the swings are not going to be very large, either up or down. But with growth stocks, the volatility is much higher and you can see that in our graph where our model portfolio is up and down like a yo-yo.
Luke: So let’s get into each of our stocks. We have 15 picks and what we’re going to do in today’s year-end run-through episode is do a quick whizz through all of them and just pick up key news and really give some reflections on the overall thesis for the year
Shopify
Luke: And shall I kick things off with Shopify?
Albert: Yeah sure, Luke, I think this is one of your favourite stocks right?
Luke: It is. And actually, in my real portfolio, this is one that’s buoyed up my results over well, many years, but particularly this year. So the piece of news I found on Shopify that I thought it was quite interesting was their commitment to cryptocurrency and more recently NFTs, non-fungible tokens. It seems like Tobi Lutke is a massive fan of NFTs. He’s personally purchased the tobi.eth domain and he also now has a glasses and hat-wearing CryptoPunk avatar that looks surprisingly like him on his Twitter.
Albert: I think you’re assuming that he bought it because he’s a billionaire, but maybe he’s just copied it?
Luke: He does actually own it, he purchased NFT CryptoPunk number 1719 on the 11th of December. So it’s actually quite a new initiative for him. More importantly though, Tobi’s company Shopify now enables minting, trading, and holding of NFTs themselves through a partnership with GigLabs.
Albert: Yeah, NFTs and cryptocurrencies have really been a theme for this year. A lot of companies have pivoted or expanded into this area. As a quick reminder of what an NFT is, NFT stands for ‘non-fungible token’, and the best way to view this is that it’s a digital asset whose ownership can be verified on the blockchain.
Luke: And what Shopify doing is quite interesting. They’re actually doing to NFTs the same thing they’ve done to other marketplaces. And now they’re allowing their business customers to sell NFTs while still retaining control of their own branding, customer experience, and data. And they’re allowing NFTs to be purchased via ShopPay, credit and debit cards, as well as by cryptocurrency. That’s actually quite a new capability, being able to buy NFTs with fiat currency, with Dollars and Sterling.
Albert: I remember last week you made a prediction about NFTs, what was that again?
Luke: Yeah. My prediction for 2022 or one of them was that NFTs would see a real-world implementation in representing ownership of physical goods, probably in an emerging market somewhere. And so Shopify are definitely helping push the world towards that and adding credibility to NFTs.
Albert: Did you make that prediction before or after reading this piece of news?
Luke: Uh before, definitely.
MercadoLibre
Albert: Okay Luke. So moving on to the next stock, which is MercadoLibre, the e-commerce giant in South America. MercadoLibre’s stock has had quite a rocky year and since the beginning of the year, it has bounced between a return of plus 23% and minus 36% several times. And at the end of Q3, it was down just 2.3%, not great, but also not too worrying either. However, in Q4, the share price has plummeted and has ended the year down around 24%, which is a bit disappointing.
The decline started in the middle of November when MercadoLibre announced a secondary stock offering of 1 million shares at a price of $1,550 each, which was actually 5% lower than the share price at the time, so obviously that caused some selling pressure. The company said that these sales proceeds were for “general corporate purposes”, which isn’t particularly reassuring if you ask me.
Luke: It is very suspicious, isn’t it? Did they really have no other rationale for why they were raising capital?
Albert: I couldn’t find one, but they have said they want to expand their credit services to both sellers and buyers, but they didn’t say that was the reason for the secondary offering. So again, that wasn’t particularly reassuring and shortly afterwards, growth stocks, in general, took a dive taking the stock even lower. I think one reason why MercadoLibre’s drop has been quite high is rising inflation, not just in the US but also in South America. Inflation is hovering around 10% in Brazil, one of their key markets.
However, MercadoLibre’s is business is still growing at a rapid pace. And in Q3, their latest quarter, it saw a 66% year-over-year revenue growth, when measured in USD, with gross merchandise volume up 30% year over year. So while the stock has been a disappointment in 2021, it’s worth noting that the stock is still up 116% since the beginning of 2020, as the growth was greatly accelerated by the pandemic. So if you zoom out, the stock is actually doing fine.
Sea Limited
Luke: And let me pick up our third e-commerce pick Sea Limited, and then we’ll have a bit of reflection on that whole segment. They’re doing pretty well compared to MercadoLibre and they’ve actually finished the year up. It’s one of our few winners for the year, but still massively underperforming the S&P. They were looking really good at the end of Q3, up 55%, but they’ve taken a battering and Q4 along with everybody else, and they’re finishing the year up 6.7%.
Albert: That’s a pretty big drop Luke, it dropped 31% in Q4. What was the reason for that?
Luke: Yeah. So the main reason for the sell-off, other than just growth taking a battering was because of lower guidance for growth in Sea’s game division, Garena in Q4. Garena’s key game, Free Fire, has been the massive revenue generator powering all of Sea’s international expansion over the last couple of years, but Free Fire is now four years old. And actually, Garena doesn’t seem to have another game property that’s getting the same kind of attention. There’s not much in the pipeline. And so the market’s getting a bit nervous that perhaps this cash cow is starting to taste a little like overcooked steak.
Albert: Great analogy, Luke. How long did you think about that?
Luke: Over lunch yesterday.
Albert: By any chance having steak?
Luke: Um, ceviche, Albert. Anyway, as we reported in our Q3 update, Sea are expanding aggressively into Latin America intruding on MercadoLibre’s territory, and also into Europe and those plans are going to continue to require significant capital from other parts of the business, particularly Garena, to sustain the growth. So I think it makes sense that growth investors have suddenly got very nervous with what was otherwise a fairly small reduction in forecasted growth. So one to watch I think.
Albert: Definitely, I think the fact that they only have one hit game in Free Fire is a major concern because the revenues from that gaming division is funding the expansion in the other divisions in online shopping and their e-payment platform. So if Garena stumbles, the whole company could stumble.
Luke: So overall our e-commerce stocks as a basket has done pretty well. Sea is up a little bit. Shopify is parity with the market, MercadoLibre’s underperforming quite substantially, but I think we’re happy with these three stocks that they’re part of our portfolios for years to come.
Albert: And to be quite honest, Luke, the one I’m least worried about is MercadoLibre, even though it’s underperformed. You have to remember this is still a relatively small company, it’s only $66 billion in market cap, and it has a huge runway to go.
Luke: Yeah. I buy that too. I’m certainly not selling any of these three. Take us into fintech, Albert. Let’s hear about Square.
Square
Albert: Yeah, our fintech pick for last year was Square and Square has had quite an eventful year. At the beginning of the year, it acquired Tidal from Jay-Z, causing a lot of people to scratch their heads wondering why Square would buy a music streaming service. Then it bought even more Bitcoin, and near the middle of the year it acquired the Buy Now Pay Later giant, Afterpay. More recently, Jack Dorsey stepped down as CEO of Twitter to become full-time CEO of Square. It still amazes me that Jack Dorsey was able to be CEO of two massive companies. And all the while, Square has continued to grow its seller and Cash App ecosystems. And one thing that many people would have noticed is that Square changed its name to Block in December.
And like Facebook’s name change to Meta, Square’s name change appears to point to where the company is going. So Facebook is signalling a move to the metaverse, and I think Square may be saying that they will focus more on blockchain-related technologies like cryptocurrencies and crypto-assets.
It’s quite a clever name because a square is also a block of sorts. And you could also give this many different meanings, so even though I don’t like the name myself, it is quite clever I think.
Luke: Yeah, I buy the rebranding and the focus, but actually, the more important piece of news I think is probably Dorsey moving across and focusing full-time on Square. Do you remember, mid-year we had a bit of a jokey episode and we were chatting about, which was his favourite of the two companies, and if he had to choose who would he choose? And I think we both said we thought he’d pick Square, and there you go that’s exactly what he’s done.
Albert: I remember the question but I don’t remember the answer.
Luke: I think I said that because. Twitter comes with such a headache of regulation and oversight and pain. Whereas Square’s kind of his new baby and it’s doing something really exciting. So actually as a Square shareholder, I’m pretty pleased that Dorsey’s turned his prodigious mind to focusing on this company and driving it in what looks like a really positive direction. And as a Twitter shareholder, I think I’m also actually quite comfortable that he’s handed over the reins because that company was just been going nowhere for a good eight or nine years.
Albert: You’re very easy to please, Luke.
Luke: I just want my CEOs to focus.
Albert: I think they should, as I said, it still surprises me that he was able to be CEO of these two massive companies. That guy must get no sleep.
But looking at Square stock, it was doing fine for most of the year. Again, as with most other growth stocks, it has fallen off a cliff in Q4, dropping 30% and ending the year down 17%, which is pretty disappointing. But long-term shareholders have been richly rewarded as the stock is up 13 times since its IPO in 2015.
But as investors, we need to look at the future and their ecosystem of services and apps is continuing to strengthen, but the fintech space is changing quickly with increasing competition, and I see their pivot into the blockchain and crypto-assets as both a risk and an opportunity, but this is the nature of growth investing.
Guardant Health
Luke: Alright, well, let’s take it out of fintech and e-commerce and into health tech. And this is a sector that has done pretty disastrously along with everything else. I’m going to open this one though with Guardant Health, which is a company I’m fully committed to and really believe in. And Guardant have got a really interesting milestone they’ve just passed. One of their key initiatives for the last year or two has been something called their Eclipse program. And Eclipse is a study to evaluate the performance of the company’s Lunar-2 blood test, to detect colorectal cancer in average-risk adults.
So today it’s estimated that one in three adults in the US don’t adhere to national colorectal screening recommendations, even though screening has been shown to improve survival rates. And it’s because colorectal screening methods are time-consuming, and if you have to have a colonoscopy, basically like a camera up your backside, invasive, not the most pleasant procedure.
So the real benefit of Lunar-2 is if it’s successful, they can screen effectively for colorectal cancer with a simple blood test, and that’s much easier, cheaper, far less invasive, and it’s just going to get much better take up from average-risk adults. And so the key milestone for Eclipse was that they wanted to sign up 10,000 patients for their study, and at year-end, they’ve got to 12,750. So this is actually a key milestone, and when they start to analyze the results from these 12 or 13,000 patients, that will be preparing them for an FDA submission, hopefully in 2022.
Albert: We’re quickly approaching the age where colonoscopies are recommended. It’s not something I’m looking forward to, but you know, you have to do it.
Luke: Yeah, well, maybe you just have to give blood if it’s a couple of years’ time, rather than having a film crew examining your bowels.
Albert: Yes, Luke, I’d rather just give a blood sample, thank you. I hope that option is available in Hong Kong.
Luke: I’m sure in Hong Kong, you can pay recreationally to have someone stick a camera up your ass.
Albert: Only the establishments that you visit, Luke!
Luke: Let’s move on! Let’s move on!
Editas Medicine
Albert: Moving onto our second biotech stock, which is Editas Medicine. And Editas Medicine develops gene therapies based on CRISPR CAS-9 gene editing, and its main therapy is to treat a condition called LCA 10, a genetic disease that causes blindness. And this is currently undergoing clinical trials. Results so far have demonstrated good safety but limited efficacy. And this stock hasn’t done very well in 2021. So far year to date it is down 53.3%, not quite our worst-performing stock, but pretty close.
And we have said in a previous episode that it was probably a mistake to include Editas in the model portfolio, given that Editas is more speculative with a higher risk-reward profile. And it’s probably more appropriate to treat it as a hyper-growth stock. And personally, I’ve been starting to think about it this way since the middle of the year, and I stopped adding to my position and kept it as 1% of my portfolio.
Luke: I do like that we’ve both kept some exposure to the real forefronts of genetic medicine. And Editas are certainly leading the way with CRISPR CAS-9. But you’re right, it’s going to be a highly volatile pick, and really all biotechs, they always have the possibility of literally going to zero, and I guess Editas is no different in that respect.
Albert: Yeah. Another key risk with Editas is that it’s first-generation gene editing, and first-generation gene editing has some inherent problems.
Intuitive Surgical
Luke: Let me uh, take us to the other end of the maturity in the health market and cover Intuitive Surgical, one of my key stocks in my own personal portfolio. They’re doing pretty good, they’re one of our big winners for the year and they’re finishing the year up 44%. And actually, they’re one of the only stocks that increased in value in Q4, up 10% in that final quarter. We did a deep dive on Intuitive earlier this year with analyst Adu Subramanian. And our conclusion on the episode with Adu was that Intuitive Surgical’s outsized growth days are probably behind them, but we’d expect them to be a strong and steady investment for the future, maybe with optionality. And I think that thesis remains broadly intact.
Well, in terms of recent news, nothing major, but I did note that Intuitive have now announced that they have performed more than 10 million surgeries worldwide on their platform and their CEO, Gary Guthart said, “While we’re proud of this milestone and momentum, this is really a moment to look at what we’ve learned from these 10 million procedures, and ask ourselves how we can apply that to improving the field of surgery for years to come”.
And this quote really made me think of the conclusion in our conversation with Adu, where Adu called out the key data advantage that Intuitive may have over their competition. They’ve got key data from these 10 million actual procedures, which they could use to inform future surgeries and training, nudging surgeons to make the right incision or perhaps avoid what’s been proven to be a bad outcome in the past. A bit like Tesla clocking up those hundreds of millions of real miles on the road, this data advantage could be something that sustains Intuitive’s advantage and their moat over the competition for many years to come.
Albert: And I know, Luke that Intuitive Surgical is one of your favourite stocks, a stock that you have vowed never to sell, and given its performance this year, it’s quickly becoming one of my favourite stocks as well. It ends the year up 44%, beating the S&P 500 index.
Teladoc Health
Albert: Moving on from one of our best-performing stocks to our worst-performing stock, Teladoc Health, and this is down 66% for the year. I guess it was just luck of the draw that I’ve been given the worst-performing stock in our portfolio to cover in this episode, I can only assume that it was by pure chance, but Teladoc has been a disaster for the model portfolio.
It has been our worst-performing stock in all previous three quarters, dropping more each time and Q4 is no different. It dropped a further 26% in Q4. I won’t go into Teladoc in too much detail, as we discussed Teladoc with Richard Chu on the podcast just last month, and he had some really interesting insights on Teladoc and why he sold his position in early 2021, so I recommend revisiting that episode if you want more detail. But just to give you a sense of how far it’s fallen, Teladoc acquired Livongo in October last year for $18 billion, and today the combined company has a market cap of just $15 billion. Management must be scratching their heads at that one.
I’m not quite ready to throw in the towel just yet and sell my shares, but it could be a while before it recovers to its all-time high achieved in February of this year. That would require a gain of 210% from today’s prices.
Luke: Yeah, it’s not been pretty. And Teladoc was particularly painful for me because it was the gift I bought for all of my nieces and nephews, but I’m also committed to this one for the long term. I don’t have a huge exposure to Teladoc. I’m certainly not going to chase my losers and double down or reinvest in this one, but I am standing firm. I do think their capabilities are going to be needed increasingly in the future, and they do seem to have one of the better platforms with the acquisition of Livongo.
Albert: When you use phrases such as sunk cost and double down, you’re basically telling people you’re a gambler.
Crowdstrike & Cloudflare
Luke: We’ve talked in the past about parallels between poker and investing, there’s certainly common skill sets. But let’s move on from health tech and get a little bit more techie tech and I’d like to touch on actually CrowdStrike and Cloudflare together, cause there’s been quite an interesting piece of news just in the last month that many of our listeners may have run into.
But first the overall performance, both stocks have done okay. CrowdStrike finishes the year plus 4% after a fairly precipitous 14.7% drop in Q4, and Cloudflare is our best performer overall. They finished the year plus 86% after a stellar Q4 of plus 23%. That Cloudflare performance has really held up many of the losses in the model portfolio. And it’s also supported both of our personal portfolios this year. It’s one of those stocks I had to trim cause I was getting a little bit outsized.
Coming to this significant piece of news in the last month, in late November, a vulnerability was identified in something called Log4J, which is an extremely widely used Java library used for logging. And it’s actually been quoted by some members of the industry as being the single biggest, most critical vulnerability of the last decade and possibly the biggest in the history of modern computing. And actually, Log4J is so widely used that even I recognize this one and I’ve used it myself back in my techie days, and I am a total dinosaur. That just tells you how long Log4J has been around and therefore, how many different systems, pretty much anything that’s written in Java, is using it.
Albert: What does Log4J do?
Luke: It’s actually just for logging. So if you’re writing software and you want to stick something in a log so that a system administrator or someone can examine and see what the system has been doing, then you’ll use Log4J just to write it out to your log file. And this vulnerability was found, in fact, in the game, Minecraft. Evidently whenever players chat to each other, because someone could be abusing another player, well the system uses Log4J to log what was said, just so as a record of it in system logs, and they can do some analysis and if a player has been abusive, they can kick them off. This vulnerability in Log4J, once it was discovered, meant that if a player sent a chat message that was specially constructed with special characters, they could actually execute code on the recipient of the chat messages computer.
So that meant you could basically install Trojans and all sorts of other malware on the guy you play in the game with, and they’ve got no defence against it. So there’s a simple example of the vulnerability, but actually, the vulnerability has also been demonstrated, albeit I don’t know if the actually caused any real damage in the real world, but demonstrated on iPhones, and would you believe Tesla cars. Literally, by simply renaming the car to a string of special characters, an attacker has been able to force a backend Tesla server to visit a website of their choice, and that potentially exposes Tesla to remote code execution, which could be disastrous.
Anyway, however, you look at it, this is extremely serious. And the real trouble with this is that even though the underlying problem has now been identified and fully fixed, it’s going to take some organizations months to patch their servers. And over that time, they’re exposed to attacks which are happening right now.
So the reason I picked this news item up for Crowdstrike and Cloudflare is that they both have very strong IT security capabilities. And that is the whole ethos of Crowdstrike, but it’s a key part of Cloudflare’s capability too, and they’ve really been on the front foot with this vulnerability. They’ve been all over it and their core IT security capabilities are really going to be essential right now, as their customers need to defend against attacks that are going to result from this Log4J vulnerability.
Albert: You mentioned Tesla, Luke. And this reminds me of a story I read recently where Tesla has disabled a function to play games while the driver is driving. And it surprises me that it was enabled in the first place. Ostensibly, the games would be placed by the passenger, but the driver could easily override this by pressing the button, ‘I am the passenger’.
Luke: It’s not as bad as you think, I have tried to do that myself. You can run certain bits of entertainment while you’re driving, but you’ve still got a lot of your navigation and other key controls visible, and certainly, some of the full-screen games can’t be played while you’re driving.
Albert: Okay, fair enough. Yeah. I was thinking that maybe the driver could be playing a driving game whilst driving, and that would be disastrous!
Luke: There is a hilarious driving game. I forget the name of it, but you do control the game with the steering wheel, the brake, and the accelerator in the car. I played it on the driveway for about 20 minutes, and then when I got out of the car, I realized I was actually rotating the tires and I was probably like wearing a flat spot into the front tires, playing this bloody game.
Albert: I just can’t believe anyone thought this was a good idea.
Luke: You can install an Xbox controller to play it with that rather than the actual steering wheel, that might be more sensible.
Twilio
Albert: Fair enough, but moving on, I’m covering Twilio. And because I’m covering it, surprise, surprise, it’s down for the year. It’s down 22% for the year. The share price started to drop after their Q3 earnings at the end of October, where they signalled slowing growth and increasing losses. They did quite well in Q3, they actually grew revenue 65% year over year, but they were guiding for revenue growth in Q4 of 40% a lower rate of growth, but still 40%.
And also their dollar-based net retention rate was 131% compared to 137 last year. So while the company is still growing, its growth appears to be slowing, but as I said, 40% year over year growth is still pretty good. But they also guided for a much higher loss in Q4 than expected as the costs of running the communication platform are increasing, cutting into their operating margins. But the good news is that newer software-based services such as Segment, Flex, Frontline, and Engage should help to improve margins as they scale if they can scale.
Twilio has also made a number of acquisitions this year to expand its capabilities, most notably ZipWhip, which enables texting using landline numbers, which is particularly useful for businesses, so customers can call or text using the same number. I think Twilio is another case of growth being pulled forward by the pandemic, so year-over-year comparisons were always going to be difficult and the stock is still up 153% since the beginning of 2020, which is no consolation to anybody investing this year, but you have to zoom out as long-term investors.
Fiverr
Luke: Okay Alb, you’ve been moaning, but here’s my chance to pick up a disastrous loser. I’ve got Fiverr, albeit it’s a company I love, and I think they’re doing some really smart stuff, but they had a disaster of a quarter. Fiverr were down 37% in Q4, and they finished the year down a hair under 45% So really a disastrous stock performance, but I actually really like what I’m seeing from the company in terms of evolving their strategy and maturing the marketplace for the services they offer, not the least of which, because I bought a fantastic Christmas gift from my brother, Matt, using a Fiverr artist.
Albert: You mentioned that in the last episode, what was the gift?
Luke: It was a beautiful painting of their dog, Bailey, in historical military costume looking extremely grand. And from Costa Rica, I managed to get the painting created, got a high-quality image emailed over, and then I was able to send that to a printing and framing company and get it delivered in time for Christmas day, and I’m hoping Matt is delighted with it.
Albert: Oh nice. Very bespoke gift there.
Luke: Absolutely. Well, anyway that’s just one of the hundreds and hundreds of services that Fiverr sellers provide. I say I like their strategy, well at the start of this year, Fiverr launched Subscriptions, which has a new feature, which allows freelancers and buyers to establish a much longer-term ongoing relationship rather than one-off gigs.
More recently, Fiverr have announced a partnership with a company called Stride Health. And what Stride do is help Fiverr workers get access to affordable health, dental, and vision insurance. And so what the companies are doing now is working together to raise awareness of subsidies and tax credits available to Fiverr gig workers and educate them around easily obtaining cost-effective healthcare. And that’s really important if you’re in the gig economy. If you’ve stepped outside of the formal workplace, potentially you’ve lost access to a lot of the health plans and things that were really essential to have a safe life for yourself and your family in the US where health is so expensive, as we know. So I just really like the direction that Fiverr leadership are taking the company.
I think it’s very suitable to current times with so many people leaving the formal workplace, me included. The gig economy is here to stay and it’s only going to grow. And I think with capabilities like Subscriptions, and providing workers with stability and benefits they need to thrive, Fiverr are really going to continue to gain market share, and increasingly have a broader range and depth of services hosted on their platform.
Walt Disney
Albert: Moving on to entertainment, our pick for entertainment last year was Walt Disney, a company that most listeners should be aware of. And we did a deep dive of Disney just a few weeks ago, so I won’t spend too much time on this one. But quickly, the pandemic has continued to hinder Disney’s theme park, cruise line, and movie business. Although ‘Spiderman, No Way Home’ begs to differ, which has so far grossed over $1 billion in just two weeks. However, I believe the movie is distributed by Sony Pictures, so it may not be a big line item for Disney.
Their transition to streaming is continuing, but it recently shows signs of slowing down after an extremely strong start two years ago. The company has returned to profitability this year, but it is still below 2019 levels. I think I mentioned in an earlier podcast that I see Disney as a foundational stock, and I’ve been a Disney shareholder since 2010 and it’s been a decent performer and I see no reason to sell now.
Magnite
Luke: Yeah, likewise. My turn to pick up another disastrous performer, this one’s Magnite. They started the year up 13% at the end of Q1, but it’s just been, a fairly steady fairly steep decline since then with them losing double-digit percentages in every quarter and 35% in the most recent quarter. So Magnite are finishing the year down 51%.
No major news for Magnite, but there is one thing that I think is a little controversial. They announced just a couple of weeks ago that they’ve approved a share repurchase program for $50 million of common stock. So they’ve got the ability to buy back their own stock over the next 12 months. Now on the face of it, it’s probably a good idea to buy back the stock while the valuation is heavily suppressed. And there could be a good explanation if this is about avoiding further dilution from stock-based compensation next year, which was $30 million in 2020. But overall, personally, I honestly see it as quite a poor reflection on Magnite’s management.
Comes back to my concerns around dividend stocks, right? Companies that buy back their own shares or issue dividends typically are companies that have excess capital and no better way to use that capital. And if that’s really true for a young growth company, like Magnite, it does give me cause for concern that maybe management aren’t seeing good opportunities to grow market share and develop their capabilities, so it’s a bit of a worry. Overall though, I suppose it’s not that material. $50 million is about 2% of the issued share capital, so it’s not that big a deal. And I guess management have taken this step as an attempted show of confidence in their own stock, but I’m afraid to say that show of confidence didn’t work for this investor.
Albert: But I think overall, you don’t really like dividends and share repurchases. I think you prefer your companies to reinvest in the business and grow their total addressable market. But I believe most share repurchases are shareholder-friendly because it’s the opposite of share dilution. Your shares become a bigger part of the pie when it comes to ownership of the company. And I believe when we read the book 100 Baggers, most of them have quite heavy share repurchases. One of the biggest rebuyers of their stock is Apple, the biggest company in the world.
Luke: But then I think Apple is an exception, right? They’ve got so much money, it’s actually quite hard to leverage their capital. If you’re a little company like Magnite, and you’ve got a couple of hundred million dollars kicking around, I’m a bit worried if you can’t find something better to spend that money on than just buying back your own stock.
DocuSign
Albert: That’s a fair point, Luke. And the next stock is DocuSign. And again, I don’t want to use the same language, but it had a disastrous Q4 dropping 40%. As a reminder, DocuSign is the leading e-signature service and contract lifecycle management provider and has a suite of services that they call the Agreement Cloud. DocuSign was showing a return of 14% at the end of Q3 but had a massive drop in Q4 after their earnings. And the reason for the drop was slower projected growth for Q4. So in the Q3 earnings, they actually beat expectations. But for Q4, they are estimating revenues of around $560 million at the midpoint, while analysts had expected 574 million. It’s not that much different, but this would represent a 29% year-over-year growth for Q4 versus the 44% growth they achieved in Q3. So growth stocks were already under pressure in general, and I suppose this news was the straw that broke the camel’s back, sending the stock down 40%.
Luke: Yeah. I remember that day, precipitous drop in one day. Pretty wild.
Albert: Yeah, it did feel like an overreaction, but you can’t doubt the market, that is the price that people are willing to pay.
Luke: Yeah.
Albert: But again, DocuSign had experienced growth that was pulled forward by the pandemic, and in the earnings call CEO, Daniel Springer, said as much by saying, “After six quarters of accelerated growth, we saw customers return to more normalized buying patterns.” And I think several stocks are in similar situations with growth being pulled forward and now seeing normal growth. Other than the ones we already mentioned, two that spring to mind are Zoom and Peloton, both big winners last year, but this year have been big losers. And this is partly due to growth being pulled forward, but Peloton are having other problems as well.
While it’s not a consolation for anybody who invested this year, the stock is still up 107% since the beginning of 2020. And as I said before, a 40% drop does appear to be an overreaction for revenue guidance that is only 2.4% lower than analyst estimates, but it seems that the market now is unwilling to pay for unprofitable companies with deteriorating growth rates.
But the good news is that DocuSign has a market share of 70% in e-signatures, so much that the name DocuSign has become synonymous with e-signatures. And it still expects to grow revenues by 29% year over year in Q4 and 39% for the whole year, but we’ll have to see if they can stop growth rates from deteriorating further in the following quarters.
Luke: I feel that this was a fairly typical thing to have happened. Many of the companies we owned had got rather ahead of themselves in terms of revenue growth and stock price appreciation. Certainly, those price to sales ratios were getting a bit unwieldy for some of our companies. And so that’s really why I trimmed DocuSign and Cloudflare and a few others, in retrospect was quite lucky timing but that said so that was, so with that in mind, it’s probably quite healthy for some of these companies to reset to a more sensible price to sales ratio, and then just to have more steady, consistent growth from here.
Hopefully, the pandemic is behind us. And if these companies have now reset back to more typical, sustainable ratios for the future, then that in my mind makes them strong growth investments for the years to come.
Albert: Yeah, and it may not seem like it, but if you’re a net buyer of stock, if you’re a young investor ploughing money into the market more than taking it out, you want the stock market to get lower. You want cheaper prices.
Summary
Luke: But I guess that’s no consolation for anyone who invested in our model portfolio this year. Well, should we do a wrap-up on the whole thing? I think we’ve now covered all 15 of our stocks.
Albert: Yeah, it feels like we’ve been at this for about four hours given the bad news we’ve been dishing out.
Luke: So I think overall, clearly, and being very transparent, the model portfolio for 2021 was a complete bomb. Our intention was to beat the S&P in the year of inception and we have soundly failed to do that. But, you know what? We didn’t declare it as an objective at the start, but really and honestly, ferreting around for some snippet of good news, I did note one thing. Our model portfolio has been compared to the illustrious ARK Invest and ARK Innovation ETF, their flagship product. That’s probably true. We’re both invested in growth companies and you know what? We’ve outperformed ARKK for the year. We were down 14%, ARKK are down 22% at the time of writing. So you’d had been better off to have been a Telescope Investing model portfolio investor, at least than an ARKK investor, but clearly, you should have invested in the S&P this year.
Albert: When you said that our model portfolio has been compared to the ARK Innovation Fund, I think we were the ones who did that.
Luke: No, actually, no, that ARK-like comparison came from one of our friends, David Sawyer, who actually was kind enough to send us a copy of his book, Reset: How to Restart Your Life and Get F-you Money. I guess David won’t have made f-you money investing in the model portfolio this year, but I’m sure he’s doing just fine anyway.
Albert: Yeah, you wouldn’t have made f-you money investing in ARK this year, but you would have if you invested five years ago. So clearly, we are disappointed with the performance of the model portfolio, not just because of forms a significant part of our own personal portfolios, but also because we declared them publicly on the podcast as good stocks to invest in this year. And whether these stocks go on to underperform or outperform remains to be seen, but as far as this year goes, they have been a bust.
Luke: And I suppose, as we said at the top for, just for transparency, our own personal years, haven’t been quite as disastrous. I think I’m up just under 9% and your about six and a half percent. So that’s not a disaster. And the main reason is although we’ve both got significant investments in the model portfolio stocks, I think we’ve been lucky enough to have outsized positions in companies like Shopify and intuitive surgical. Plus we’ve also both had investments in Google and Tesla and companies like that, that have just done great.
Quote
Albert: So do you have a quote for us to round out the episode?
Luke: Yeah, so I say it’s been a tough year this year. And so my quote relates to that. It’s from a chap called Michael Altshuler, and Michael said, “The bad news is time flies. The good news is you’re the pilot.”
Albert: Thankfully. So as we end this rather depressing review of our model portfolio, we’d like to wish our listeners a happy new year.
Luke: It’s probably an inappropriate time of the year to pull out my scrappy Chinese, but I suppose the translation of the Chinese new year greeting “gung hei fat choi”, help me with this, Albert, something like prosperous wishes for the new year.
Albert: I believe it just means I wish you get money, but I think that it’s just a common theme for Chinese sayings. Chinese sayings often revolve around money and good luck.
Luke: There you go. While we didn’t get much good luck with our portfolio this year, we wish a healthy and prosperous new year wishes to all of our subscribers and listeners. Thanks for joining us on this journey. Sorry, 2021 has been a bit of a bust, but we suddenly got some very exciting certainly to share with our listeners in the future.
Wrap
Albert: Well, that’s all for this week. Thanks for listening.
Luke: If there’s a future topic you’d like us to cover, you can message us on Twitter. I’m @LukeTelescope.
Albert: And I’m at @AlbertTelescope or you can email us at feedback@telescopeinvesting.com.
Luke: If you enjoyed this episode or really any of our episodes this year, you can find more content at our website, telescopeinvesting.com, where you can leave us a comment.
Albert: And if this is your first time tuning in, perhaps consider subscribing to the website so you’re the first to hear about new articles and episodes as they drop.
Luke: Thanks, Albert.
Albert: Thanks, Luke and happy new year.
