Living Life Outside the “Media Machine”
In The Decadent Society, Ross Douthat eloquently cites W.H. Auden’s quote, “What fascinates and terrifies us about the Roman Empire is not that it finally went smash, but that, away from the start, it managed to last four centuries without creativity, warmth or hope.” Provocative-to-say-the-least, Douthat’s book captures the sense of inertia that arises when we are constantly implored to engage with endless amounts of crises. Whether it’s a global pandemic, potential world war, or the latest viral social media story, there is a sense of apathy or fatigue that sets in. Now, we’re not dismissing or invalidating the underlying issues. There are real wars and real crises that warrant our attention, but there has not always been a 24-hour news cycle that inflames and intensifies the anxiety surrounding these events.
If history has shown us anything, there have always been wars, conflicts, and outbreaks, so in a sense, this new normal is not really that new. The markets rise, and they fall and then rise again. This is very normal, but that can be very difficult to believe when every news outlet is predicting the end of existence… whether that be in the economic, political or social spheres. Somehow, if we can turn-off the “noise” around us and focus more on our personal lives and not live each day with anxiety, worry, and stress, we might just be able to enjoy our lives as they were meant to be.
“Oh, My” Opportunities
An unsuspecting opportunity has been showing up more frequently in the headlines, “Series I Savings Bonds.” So, what are these bonds, and why do they present such an attractive alternative to cash investments right now?
Essentially, Series I Savings Bonds (I Bonds) are issued by the Treasury and attempt to help savers fight inflation. People have not been buzzing about them since we have not seen actual inflation in several decades. With multi-decade high inflation, it should be clear why interest in them has been growing. In a nutshell, the interest rate is guaranteed for six months from its issuance and resets semiannually. An individual can only buy $10,000 worth of these per year and must hold it for a minimum of one year. If sold before five years, a three-month interest penalty is assessed. And now the headline number that has been making waves, the interest rate for the May 1 issuances should be north of 9.6%. That is an annualized interest rate guaranteed for holding the bond from May 1 to October 31, 2022. For any idle cash sitting on deposit earning little interest, we see that as a great opportunity for clients, assuming you can hold the bond for a minimum of one year. We continue to see this as a good alternative for more conservative clients holding excess cash savings. However, we see significant opportunities elsewhere for our clients seeking longer term investment gains which we will explore later in this article.
How Do I Buy I Bonds?
Unfortunately, we are unable to buy I Bonds on your behalf. You must open an account directly with the US Treasury and purchase the bonds onTreasury Direct. There is an excellent section discussing I Bonds in more depth on their website, which you can explore if you are interested in learning granular details. We are also willing to help assist clients in our office with the process.
What’s the Catch?
The expected +9.6% interest rate is eye-opening, but it is only guaranteed for a six-month window and then adjusts. Since price levels have risen sharply, this rate could likely fall in future adjustments. However, it’s an incredible short-term opportunity for a conservative client who may have an excess cash cushion in the bank yielding near zero percent interest. If the bond rate declines in the next year, you can sell the bond after twelve months and forfeit three months of interest. If inflation instead accelerates, the interest should reset higher and allow justification to continue holding the bond. For those clients with extra cash, we see it as an excellent place to park cash for the time being. This disconnect is solely due to the massive rise in inflation. These type of bonds can also be helpful in rising interest rate environments, however, they will not benefit from falling rates as a standard bond would. This is another reason that I Bonds have not been a preferred supplement to portfolios, as other types of bonds have performed much better over the last several decades.
Generational Opportunities Remain
So, what investments do we see more attractive for more extended time horizons or growth-oriented clients? Well, rates have moved higher, which we previously said is expected and normal for a recovery. Rates have been rising for the right reasons, and despite what’s being blared by the headlines, that’s a good thing. This rise has led to many growth-related investments to decline from what’s known as discounting future cash flows. Discounting them at higher rates yields a lower valuation today. We had previously written about how we believed this was coming and had started to “dip our toe” in the water. We’re now comfortable being waist-deep in the ocean and intend to fully dive in if the predominantly tech decline continues for those clients that the risk makes sense. We watched on the sidelines as the decline began in late 2021, which got our value-based hearts pumping. Then, the declines continued at the beginning of this year, when we spoke explicitly about recalibrating markets. We have now made investments in companies that we believe present exciting long-term opportunities. For those Braveheart fans out there, Mel Gibson is no longer shouting “hold.” We’re now taking position and understand there may be some near-term discomfort.
So, Give Specifics, Please
One example of a tech-based company that most may have heard of is Vizio (VZIO). While you may only think of their hardware business comprised of TVs and speakers, we’re solely interested in their “Platform+” business, essentially free ad-supported channels available to every Vizio owner. Vizio makes almost twice as much gross profit from this business as from all their hardware sales combined. You may think of it as a Trojan horse approach. They can sell hardware at lower profits, knowing the ad business will escalate. Platform+ was started only four years ago and has been able to double revenue every year. Now, the company will make over $400mm in revenues from this business alone with average margins well over 60%. We internally estimate this subsegment to be worth $3B. In addition to this attractive segment, the company holds almost $400mm in cash, so there is no overhanging debt concern. Backing out the cash, the business trades for less than $1B. As this ad business continues to grow, we expect the market to realize the extreme disconnect in value, leading to high rates of return in the stock. This analysis also completely ignores their hardware business, which is also profitable, just more capital intensive, typically trades at a low multiple, and is less exciting on a value basis. From a differentiator argument, Vizio is able to help advertisers utilize data to better understand the true impact of their ad reach across several platforms.
So, let’s assume we are correct, and the business realizes a minimum valuation of $3B over five years, implying a 25% return per year. This is an excellent long-term return opportunity. All else equal, if the stock continues to fall, this only makes the investment even more attractive. This example is comparable to Peloton, which we find appealing due to their streaming business, not their exercise equipment. We have discussed that business in previous posts, but the opportunity is now present in Peloton (PTON) as well, and we are actively investing in it for most clients now.
Another great example, PayPal (PYPL), the parent of Venmo, deals predominantly in online transactions. They continue to grow their reach and will do roughly $6B in free cash flow this year. The company has little to no net debt and has continued increasing revenues year after year. We believe they will continue to be a force in the financial sector in the decade ahead, and we firmly believe clients receive an extremely attractive risk and reward balance by investing in the stock for the long haul. It traded at a high of $310 per share last fall but can now be bought at $87. While its upside is not as dramatic as an opportunity like Vizio in the near term, we view this as an excellent growth opportunity. If the stock were to trade at $100 per share, it would be relatively reasonably valued. However, we view this as a long-term investment in which we believe it should be valued in excess of $200 over the next five years, representing an estimated 18% annual return. If the stock continues to fall further with no material change, we will continue to increase our weighting and hope for even more significant long-term return.
These represent just a few real examples of the many exciting investments we can now discuss and invest in with clients actively. The shopping list has become quite long and continues to grow, and we are extremely encouraged for the opportunities that lie in front of us. During the sharp decline of 2020, very few tech companies received attractive valuations. However, many are now trading below their March 2020 lows yet are in a significantly stronger financial position compared to then. As volatility may rise, we ask for patience from clients to stay focused on the long-term and to view any short-term fluctuations as even greater opportunities for the years ahead. Obviously there is no guarantee of future results, but we are very excited with the valuations we see as long term investors that we can now take advantage of. Number one rule of investing: “Buy low, sell high”!
As the markets go through normal cycles and “corrections” such as what we are seeing at this time, know that we are here to answer any questions or concerns you might have. Do not hesitate to email or call us at anytime. We will keep you posted.
Your TEAM at F.I.G. Financial Advisory Services, Inc.