2020 Q3 Review
Review of the quarter including results, market commentary, portfolio commentary, and insights.
Results
The third quarter of 2020 ended on September 30th, 2020. In Q3, the S&P 500 (SPY) returned +9.04%. For the same period, the consolidated return for Torre Financial accounts was +5.97%.
As a reminder, portfolios are tailored towards each investor’s risk profiles and investment goals. While the S&P 500 serves as a general benchmark, it does not provide an apples-to-apples comparison. Each portfolio has unique objectives and a corresponding strategy.
Review
Driven by a combination of hope, optimism, and stimulus, the market continued a steep climb throughout the summer. Big tech continued plowing ahead. The rise of option activity from both retail Robinhood traders as well as large, institutional players such as Softbank were noted as potential influences driving the market higher.
When investors purchase options from a brokerage firm, the brokerage firm typically counteracts their sale with a corresponding equity transaction. For example, when an investor purchases a call option, which is the right to purchase shares in the future at a predetermined price, the brokerage firm typically purchases the underlying security in efforts to mitigate the risk. It has been speculated that the increasing call option activity had leveraged this hedging activity, creating a flywheel effect that propelled shares higher.
While there may have been some effect, the reality is that many technology companies are benefitting from the new world regime. Coupled with the loose monetary policy and low interest rates, valuations can be expected to tick higher.
The impressive summer performance came to a pause in September. Since the all-time high reached on September 2nd, the market pullback of nearly 10% has been led by big tech. This latest retreat is exposing a potentially new trend: value stocks have been outperforming growth stocks in the recent correction.
The Fed announced a commitment to keep interest rates lower for longer. With a new policy targeting an average inflation rate of 2%, the Fed is now allowing inflation to exceed 2% in an effort to balance out the period of sub-2% inflation. More concretely, the Fed plans on keeping interest rates near 0% through 2023.
In the March-trough, when major areas of the economy where literally closed, the economy came to a standstill. Acting quickly, monetary and fiscal stimulus helped prevent a larger crisis. Having been through the worst of the pandemic, the economy is beginning to find its grounding in the new normal.
Portfolio
We maintained our disciplined approach to investing, keeping capital allocated in the best opportunities. We focused on companies that will not only weather the Covid storm, but also come out stronger.
We consolidated our portfolio. Reducing our portfolio companies to roughly 35 positions, we concentrated on the highest quality companies.
We continue diversifying from an exclusively value-focused portfolio to one that includes growth. Growth and value companies have tended to behave differently in the market. The low correlation provides benefits of diversification, which is critical for a concentrated, balanced portfolio.
A few notable highlights from the quarter:
CrowdStrike (CRWD). The cloud-native leader in cybersecurity, CrowdStrike has benefitted significantly from the shift to remote work. In the most recent quarters, CrowdStrike has grown revenue at rates of nearly 90% year-over-year. For a more in-depth review, see this article.
Cloudflare (NET). With the mission of helping build a better internet, Cloudflare continues to expand their infrastructure offerings into fast-growing areas beyond their core cloud delivery network with new products for such as Zero Trust protection and next-gen VPN services. They have proven their ability to innovate and expand with their existing customers. For a more in-depth review on Cloudflare, see this article.
Five Below (FIVE). A new position for us, Five Below is a discount retailer that is rapidly growing across the country. Five Below continues to open new locations, even throughout the Covid lockdowns. Consider their business model a mix between a dollar store (items priced below $5) and Zara (iterate quickly, staying on top of the latest trends).
Paycom (PAYC). Paycom is a modern, mobile-application-enabled payroll provider. Although set back by the spike in unemployment, Paycom posted their best quarter ever in terms of new logos as well as a 7% year-over-year increase in revenue. They make money by number of employees using the software as well as the float on the payroll. Paycom is set to benefit from both the recovery, as well as any inflation that may accompany the recent stimulus efforts.
Insights
I’d like to share insights from two books in particular that I read this past quarter. Both books altered my way of thinking about investments.
100 Baggers by Christopher Mayer
This book focuses on identifying companies that are able to grow consistently over time; and sticking with them. Many companies have become 100 baggers, returning over 100x on an initial investment. To become a 100 bagger in 30 years, a company would have to compound annually at rate of 16.7%. A company that grows faster would get there earlier.
Long-term compounding can have serious benefits. More so than the theory, the book focuses on historical examples as well as common characteristics amongst them. One common thread is the need to continually innovate, which needs to be embedded in a company’s culture to sustain any long-term compounding.
I have found the long-term perspective to be particularly useful in thinning out a long list of potential investment opportunities.
Trade Like a Stock Market Wizard by Mark Minervini
An eye-opening read, this is the first book to convince me there is value, perhaps significant value, in technical analysis. Mark Minervini is a trader. He studies stocks in search of super performance, as he calls it.
Combining fundamental indicators such as earnings or revenue growth rates with technical indicators such as volume and chart patterns, Minervini looks to identify companies that are being accumulated by large intuitional investors. The theory is that these investors continue to accumulate, driving the price higher.
Minervini looks for very specific signals. He looks for positive trends as determined by trailing moving averages, strong volume on up days, and a period of consolidation identified by reduced volatility. He purchases the stock when it breaks out from this particular pattern, typically at a 52-week or all-time high. With momentum and a strong investor base — most investors have gains in their holdings — he takes a position to ride the next leg up.
His approach is specific and prescriptive. It is important for investors to find a strategy that works for them; I won’t be adopting Minervini’s strategy directly. I will, however, pay careful attention to new signals when looking for entry and exit points.
The key takeaway: respect the market. Listen to it. Learn from it. It is often right.
Beyond the insights from those two books, I spent some time thinking about what defines a quality business. I’d invite you to read the two articles I wrote on the topic.