State of the market

Published on 12/22/21 | Saurav Sen | 1,352 Words

The BuyGist:

  • The markets have been swinging wildly.
  • We’ve been on the lookout for overreactions for buying opportunities.
  • “Opportunity meets the prepared mind…that’s the game…” – Charlie Munger
  • Our “prepared mind” starts with our Watch List.
  • In this article, we’re exploring a way to make our Watch List simpler, easier-to-digest, and more actionable.

Believable & Scalable

Our Watch List is a sieve. We’ve designed it to weed out the bad stuff. And equally importantly, it points us towards SWAN investments that significantly increase our odds of clocking in double-digit returns on an annualized basis over the long-term. We keep refining our Watch List from time to time with one objective above all – make it as easily usable as possible.

Investing is complex (not complicated; there is a difference), so we refrain from using overtly quantitative models to make our decisions for us. Instead, we keep things relatively open-ended because investing is not a deterministic science. But that makes presentation challenging. We worry about presentation because a big part of our mission at The Buylyst is to make investing less confusing and easy-to-digest. We’ve tried to be transparent about the numbers in our Watch List, but we do hear murmurs about usability. Apparently, most people don’t like staring at a table full of data. We do, but we’re a strange bunch.

For the sake of usability, we’ve been exploring new ideas. This will always be a work-in-progress. For now, we’ve come up with a simple (possibly too reductive) “Investability Score” that captures key attributes we look for in our potential investments:

  1. How scalable is the business?
  2. What are the revenue growth expectations baked into the current stock price?

Now, you will find the details of how we calculate these numbers here. In this article, we’ll stay on point – you’re probably just interested in the new Score. So, here’s our simple solution:

Investability Score = Scalability Factor – Revenue Growth we need to believe in to buy the stock.

The Scalability Factor is basically Operating Leverage; you’ll probably be familiar with the term if you’ve been exposed to Accounting or Introductory Finance. If you haven’t, no worries; this isn’t rocket science. Operating Leverage is “Fixed Operating Costs as a percent of Total Operating Costs”. The idea is that we look for firms with high Fixed Costs, especially if we expect their revenue to grow at a healthy clip. The higher the fixed costs, the higher the proportion of incremental revenue that will flow down to the real bottom-line: Free Cash Flow. That’s the built-in “leverage”.

The big, simple idea for you and us is that the market tends to underestimate Free Cash Flow growth in the long run. It’s hard to “beat” the market on short-term revenue growth forecasts or earnings reports. There is no data or analytical advantage there anymore. It is, however, still surprisingly easier to beat the market on long-term expectations of revenue growth and – especially – free cash flow growth. That’s where money is made.  Again, more on this concept here.

This simple Investability Score tells us which companies should hog our attention – companies that are significantly more likely to beat market expectations of Free Cash Flow growth over the long-term (3 years and beyond). And, consequently, their stock prices are most likely to be underpriced by Mr. Market, often because Mr. Market is too myopic about the long-term effects of Operating Leverage.

We scan the world for companies that have inherently high Operating Leverage AND relatively muted revenue growth expectations built into their stock prices. Now, whether these built-in growth expectations are believable or not (and with what probability?) requires subjective analysis. You simply cannot reduce investing down to a formula. But it’s a good way to allocate time wisely.

So, as of writing this, here are the top 20 names in our Watch List based on this new, simple Investability Score:

Fortunately, a few of these are in our Portfolio. We expect those stocks to help us beat the market over the next couple of years. And some of the other companies on this list are prominent in our research pipeline. But how did we assemble our 150-odd strong Watch List, you might ask.

If you’ve followed us for a while, you’ll know that when we think top-down, we think thematically. That’s how we look at our Watch list as well. In the next few sections, we’ll break it down by Investment Theme. We’ll list our top 5 companies in each theme. This list will guide us on how to spend our time going into the new year.

It turns out, according to our numbers in the sections below, that no fewer than 5 thematic bets are worth digging into. These are the themes which have more than 5 companies that score higher than our Watch List average. Digging into these thematic vectors is a good use of our time. The list is not surprising:

  1. AI & Big Data
  2. Healthcare Technology
  3. Media & Entertainment
  4. Retail
  5. 5G Networks

To be honest, we are surprised about Retail and 5G. We don’t have much allocated towards these themes, which may be something we’ll need to rectify. For now, our focus is on Healthcare.

We hope it will out some structure and context around your investment journey. So here goes, we start with our highest scoring companies in AI & Big Data…

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