Warren Buffett is worth more than $100 billion. Believe it or not, that $100-billion-plus net worth didn’t come out of thin air. Rather, he earned it as one of the greatest investors of all time. As such, his widespread success and wisdom has influenced countless investors over the ages — myself included.
But now it’s time to question the old ways. It’s time to look for other investing influencers to track … it’s time to develop a new set of investing rules.
If you’re anything like me, Buffett’s rules of investing — his way of defining good businesses — still drives at least some part of your thinking. But the beauty of knowing the rules is understanding how and when to break them. I bet I’m not the only one who has broken, or at the very least bent, some of Buffett’s rules over the years.
This rule-breaking has been particularly important in a post coronavirus world. After all, the novel coronavirus pandemic changed the way we all look at stocks. Whether we’re fast-money traders, meme-players, short-sellers or speculators, we’ve all likely experienced what it’s like to pick a winner.
That quest for a little extra edge has many retail investors diversifying their investments. It also has them hand-picking stocks in emerging growth areas. Remember that 20-slot punch card Buffett gave us? If you’ve dabbled in growth stocks over the last year, your portfolio probably looks like a paper punch ballot from the 2000 Bush-Gore Florida recount … more than a few extra hanging chads.
More recently, retail investors have become much more diversified. So should we worship a new fund manager now? Here’s a place to start.
The results of a recent InvestorPlace twitter poll suggest that the crowd favorite is growth investing messiah Cathie Wood. For those who are less familiar, Wood is the CEO and chief investment officer of ARK Investment Management.
Tied for second place are two equally compelling investment warriors. First, we’ve got the (not so mythical) mature unicorn lover Bill Ackman of Pershing Square Tontine Holdings (NYSE:PSTH). Ackman stands right next to the “most feared man in corporate America,” celebrity activist Jeff Smith of Starboard Value Acquisition (NASDAQ:SVAC).
No doubt, these three investors have unique personalities. But they also promote three distinct investing styles, which have made an indelible impression on the way we think about a stock’s intrinsic value.
From hypergrowth, to growth arbitrage, to “SPAC-tivists,” here’s a closer look at the investing psychology behind these investment styles, along with top stock picks. Ultimately, if we pepper a little bit of Cathie, Bill and Jeff into our own stock-picking, we might make some new rules of investing (and break them again later). Hell, putting it all together, we might even get one step closer to that coveted Buffett net worth.
New Investment Styles: The Hypergrowth Investor
Style Messiah: Cathie Wood
Investing MO: Early stage growth stories in massive (and rapidly growing) addressable markets
An iconoclastic personality and buzzy social media following earned Wood a Buffett-like fandom. But out-of-this-world performance makes Cathie the reigning investment queen. Wood’s flagship exchange-traded fund (ETF), the ARK Innovation Fund (NYSEARCA:ARKK), holds $22 billion in assets. It also delivered an otherworldly 147% return in 2020.
Wood made “disruptive innovation” a household word. She also invested big (and early) in several massive technology themes — from artificial intelligence, big data, cloud computing, cybersecurity, blockchain, digital wallets to genomics.
Many of the “Woodstocks” are aggressive, high-beta stocks which experienced meteoric gains last year. For example, Tesla (NASDAQ:TSLA), a big holding in three of Wood’s funds, gained 510% in 2020. (Side note: reports of TSLA’s imminent demise are greatly exaggerated). Wood predicts the electric car company can double its revenue growth over the next 5 years and will someday be valued at over $1 trillion. Other ARK gems include Square (NYSE:SQ), Teladoc Health (NYSE:TDOC), Roku (NASDAQ:ROKU) and Shopify (NYSE:SHOP).
Winner Takes Most
Another salient trait: Wood invests in technology leaders in a “winner takes most” market. This gives her the confidence to largely ignore valuation and invest in companies whose profits are years if not decades away. That’s most definitely not something Buffett would do.
While Cathie’s picks worked amazingly well in 2020, the market has been less kind to emerging growth stocks amid rising interest rates. ARK’s total assets are down to $52 billion (from $60 billion) — largely reflecting a cooling amid a rotation into value names that will benefit from the economic recovery. ARKK and ARK Next Generation Internet ETF (NYSEARCA:ARKW) have underperformed the market, down 4% and 2% year to date, respectively (versus a 14% gain for the Nasdaq Composite).
Success has brought about some growing pains. Huge inflows led observers to question ARK’s sizable stakes in small- and mid-cap names and the liquidity of these positions in a downturn. In particular, Wood’s strategy of selling holdings in bigger, more liquid companies during drawdowns and buying less well-traded names fueled fears that ARK would become overexposed to its most speculative bets. Wood has pushed back on concerns about ticket sizes, arguing that the companies she invested in could grow quickly, solving the problem. (Side note: ARK no longer holds a stake bigger than 20% in any stock, down from three companies in February).
A Less-Crowded Easter Egg Hunt
There’s another important bi-product of Cathie’s success: a fairly predictable herd-like chasing behavior. Investors closely follow ARK trades, provided daily a few hours after market close, to see Wood’s endorsements of stocks. That momentum has pushed stocks like data analytics company Palantir (NYSE:PLTR) into meme-like territory.
But when that herding behavior continues, that is, when a group of momentum investors chase the same stocks, it does two things. First, it can drive up the value of stocks without actually analyzing and understanding the underlying valuation of them. Second, it leaves other growth stories relatively undiscovered, like a less crowded Easter Egg hunt. That’s the reason these next two investors are on my radar.
New Investment Styles: The Growth Arbitrage Investor
Style Messiah: Bill Ackman
Investing MO: Price dislocation in high-quality businesses with incremental cash flow potential
Bringing “mature unicorn” back into the investing vernacular while spawning a thousand memes, Bill Ackman has re-defined growth arbitrage investing. Ackman’s SPAC, Pershing Square Tontine Holdings seeks out investments in durable, proven businesses. These are the kind that Warren Buffett would say have a moat around them. But another facet of PSTH’s picks is that these companies don’t yet have stock prices that reflect their potential.
Like Wood, Ackman looks for growth — but not at any price. This manager aims for businesses trading at highly discounted valuations — usually because investors have overreacted to negative macro or company-specific events. A key investment theme: finding names whose intrinsic value is driven by cash generation, not future growth projections.
Just the mention of cash generation might make a lot of self-proclaimed growth investors wince. But for Ackman acolytes, or “Tontards” (as the Reddit crowd calls them), growth and fundamental analysis need not exist separately. In fact, Ackman has shown that buying these high-quality, but mispriced stocks can unlock a double discount. A stock price often doesn’t reflect the intrinsic value of the business. Nor does it often reflect the intrinsic value of the business if it were run better.
Usually, once an Ackman holding makes a few modest tweaks, the business’ earnings and cash flow lever delivers strong upside — and price appreciation for the stock. Take for example, some of Ackman’s mispriced winners like the growth story at Chipotle Mexican Grill (NYSE:CMG), or successful turnarounds, such as Lowe’s (NYSE:LOW). Oh, and don’t forget the turnarounds of leisure travel play Hilton (NYSE:HLT) and tech giant Agilent (NYSE:A), either.
In addition to value unlocking, Ackman’s growth arbitrage investing style has other key advantages. First, the portfolio is shielded from momentum-driven volatility caused by changing investor whims. Whereas a portion of Cathie’s portfolio consists of “fast-money” plays like special-purpose acquisition companies (SPACs) and electric vehicle companies, whose fortunes can change very quickly, Ackman’s names tend to be owned by investors with a longer-term investment horizon.
Second, because these businesses are presently delivering cash flow and earnings, their valuations are more insulated against rising interest rates.
Know When to Fold ‘em
While Wood has been criticized for the concentration of her portfolio, Ackman isn’t afraid to take money off the table. In May, PSTH announced it had exited its wildly successful position in Starbucks (NASDAQ:SBUX) to acquire a roughly 6% stake in Domino’s Pizza (NYSE:DPZ). The thesis: It’s a simple free cash flow business suffering from temporary price dislocation. With a digital delivery infrastructure and the largest owned in-house delivery network, Ackman sees a combination of exceptional economics and the potential for continued share gains.
For r/PSTH’s 16,000-plus Tontards, PSTH stock has been a bumpy ride lately. First there was Ackman’s eyebrow raising decision to use a SPAC to buy a minority stake in another company. This MO didn’t follow the usual SPAC investment pattern, which is to merge with and take its target public. Second, there was this week’s announcement that PSTH backed out of its deal to buy a 10% stake in mega-music publisher Universal Music Group from Vivendi (OTCMKTS:VIVHY). The reason: objections from the Securities and Exchange Commission relating to NYSE listing rules.
Tontards are spinning a positive narrative. PSTH can conserve its firepower for a larger acquisition. While the identity of the SPAC’s merger target is still unknown, payment companies, including Stripe and Plaid have been mentioned as potential candidates. The increasing valuation for these expensive unicorns could be another reason for PSTH wanting to maximize its $4 billion cash war chest.
New Investment Styles: The ‘SPAC-tivist’
Style Messiah: Jeff Smith
Investing MO: Build stakes in undervalued businesses and force operational and/or strategic changes to unlock value
There’s another investor with an eye for detecting unrealized potential in companies: activist investor and hedge fund manager Jeff Smith. The hedge fund he manages, Starboard Value LP, is known for executing big sweeping changes at its target companies. In 2014, Starboard ousted the entire board of Olive Garden-owner Darden Restaurants (NYSE:DRI), a stunning shareholder coup. In less than two years, Smith oversaw a stunning turnaround at the company, resulting in a 40% appreciation in Darden’s stock price.
Starboard builds stakes in undervalued companies with inefficient management. It then forces them to make important operational changes to correct course and unlock value. About 80% of Starboard Value’s activist campaigns have been profitable, while the fund posted annualized returns of 15.5% through 2014. Famous activist targets include The ODP Company (NASDAQ:ODP), Macy’s (NYSE:M) and Papa John’s Pizza (NASDAQ:PZZA).
Finding the Value in Growth
More recently, Smith is trying his hand in SPACs. Starboard Value Acquisition, which raised $360 million in its September 2020 IPO, announced its first merger target, data-center firm Cyxtera Technologies. Formed in 2017, Cyxtera consists of 57 data centers owned by CenturyLink, now known as Lumen Technologies (NYSE:LUMN), with four cybersecurity and data analytics companies.
If Ackman mostly hunts for mature unicorns, Smith’s target is on the younger side. Valued at $3.4 billion, Cyxtera is an early stage company in a well-established, rapidly growing market with strong secular tailwinds. Smith’s target could have room to grow from a valuation perspective too.
In 2020, data center real estate investment trusts ended the year as the best performing REIT sector, accumulating a total of 21% annual return. Cyxtera’s closest equivalents, Equinix (NASDAQ:EQIX) and Digital Realty Trust (NYSE:DLR) command lofty multiples of 31x and 26x forward AFFO (Adjusted Funds From Operations). With improved revenue growth and utilization, Cyxtera may experience a valuation recalibration closer to these peer multiples.
Your comments and feedback are always welcome. Let’s continue the discussion. Email me at email@example.com.
Joanna Makris is a Market Analyst at InvestorPlace.com. A strategic thinker and fundamental public equity investor, Joanna leverages over 20 years of experience on Wall Street covering various segments of the Technology, Media, and Telecom sectors at several global investment banks, including Mizuho Securities and Canaccord Genuity.
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