Quick Thoughts: Stock Picking is Coming Back!

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SEE LAST PAGE OF THIS REPORT Paul Sagawa / Tejas Raut Dessai

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March 31, 2020

Quick Thoughts: Stock Picking is Coming Back!

  • Most companies will be late to report 1Q results and smart managements will throw in the kitchen sink to leave as much dry powder as possible for future quarters. Do not expect any forward guidance and if you get it, take it with considerable skepticism.
  • Amidst the uncertainty, analyst estimates will diverge far more than usual. Near term surprises will not have a lot of meaning. Estimates for next year are likely to be much more inaccurate than usual (which is already very inaccurate).
  • In the absence of trustworthy estimates, narratives will drive stock performance even more than usual. Managements’ ability to “sell” a story to investors will be rewarded.
  • The global TMT landscape will change dramatically as a result of the pandemic. We think the emerging themes are likely to include: 1. Work-at-home/cyber security; 2. Enterprise cloud; 3. Streaming media/digital ads; 4. E-commerce for everything; 5. Telemedicine/clinical AI
  • Big share swings will play out all over TMT based on positioning, vision and execution as we come through this crisis.
  • Stock picking will be paramount. The best managers should broadly outperform their peers and the indices until things settle down. It could take many quarters before things settle down.

In a normal year, 1Q earnings would be starting up next week. While there may be an intrepid few whose financial systems are robust enough to close the books on time with everyone working from home, most companies will be late this year. Some will be VERY late, as accounting for sales through global distribution will be messy indeed. When companies DO report 1Q results, in most cases they will disappoint vs. consensus expectations that have not really adjusted to the crisis underway. A few companies selling products well canted toward a world of social distancing will have upside surprises. Many of these stocks have already become investor favorites and others will become favorites once their beneficial position becomes apparent.

Once they are ready to report, the companies with bad news are very likely to dump in any stray bad news that they’ve been kicking forward and clear the decks. A classic “kitchen sink” quarter writ over hundreds of times in hundreds of conference calls. While we all wait for global and local inflection points to tell us that the worst of it is over, precise guidance is effectively worthless and managements will be loath to give it. If a CFO or two gets overambitious and sets narrow bounds for sales and earnings 3 months out, investors should take it as hubris as opposed to some sort of special predictive skill. This will be very hard on the sell side – they are used to taking guidance and then edging their numbers up or down at the margin. Without management’s take as a baseline, they will have to come up with something on their own. Likely, the range of estimates will be far wider than usual for most stocks. Importantly, the incidence of surprises – upside

Ex 1: Magnitude of avg. top-line surprises for S&P500 and S&P 500 IT was erratically higher immediately post 2008 sell-off as analyst estimates floundered

Ex 2: Quarterly breakout of magnitude of top-line surprises post the 2008 sell off

and downside, sales and earnings – will rise in both frequency and magnitude. This was true as 2008 played out. Surprises were up big time and the effect lasted for more than 2 years (Exhibit 1, 2, 3).

Ex 3: Distribution of incidence of companies meeting and exceeding estimates, for S&P 500 and IT components, post the ’08 selloff

In the absence of reliable estimates with which to judge quarterly results, we expect narratives to drive stock movement. The unprecedented sequester of hundreds of millions of people, now working at home, learning at home, shopping at home, and playing at home will catalyze changes in behavior that will persist beyond the crisis. Self-interested players all over the map will assert their own prescience and claim advantage. Managements will spin. Analysts will spin. Media pundits will spin. Some of the spin will be on target, some will be fantasy. Investors who can suss out the best themes and the top companies in position to exploit those themes and beat the rest of the market to the punch, will be very well rewarded.

In the TMT landscape, we see 5 pre-eminent themes. The first is work-at-home. During the crisis, the closure of offices and universities has more than tripled the number of adults in developed economies working or studying remotely. They are already buying new gear, straining videoconferencing platforms and signing on to SaaS collaboration applications in droves. Once the offices and campuses reopen, a number of these workers and students will continue to work remotely and the solutions needed to support them will be permanently on higher sales trajectory.

The second theme is the enterprise cloud. Cloud based solutions – SaaS applications and public hyperscale datacenter hosting – are far more flexible, more powerful, and generally cheaper to operate than traditional internal IT options. The transition was already at a full roar, but with the specter of a second wave hanging like a sword of Damocles, we think the roar will get even louder.

The third is streaming/digital advertising. Linear TV was already in trouble. Now with no sports to compel hardcore fans to pay up for a $100/month cable package, we think cord cutting will see a step function move up. Meanwhile, social networks, gaming platforms and streaming services are thriving with three continents of bored shut-ins binging their content. Advertising is down now, as it is in every recession, but a kickstart will drive millions of businesses to get the word out and digital is the way to reach those consumers. This will turbocharge the media landscape shifts that we were already seeing.

E-commerce for everything is the fourth theme. Amazon had already laid waste to categories like bookselling, housewares and office supplies. Now a world of consumers is getting comfortable with grocery delivery, wider food delivery options, prescription delivery, etc. Essentially everything delivery. A lot of cultural barriers for shoppers blown away by their 3 months in captivity. The elderly, long the biggest holdouts from online shopping, will now be true believers. However, we note there may be some speedbumps ahead, as labor availability during the pandemic could be badly squeezed.

Finally, telemedicine/clinical AI. Insurers have no choice but to agree to pay for online video consultations, eliminating a huge holdup for telemedicine. Once doctors are confident in this, expect it to become commonplace, making routine checkups pain free and low cost for patients. Similarly, the cooperation on developing treatment protocols for coronavirus during a shortage of health care professionals could introduce new AI-assisted triage and diagnosis solutions. We suspect that we are at the beginning of new era in the development and deployment of clinical healthcare technology.

Of course, it is not enough to include the right buzzwords on your PowerPoint presentation. Management is going to matter and making the right call on winners and losers within the narratives will be critical. For example, from the horde of would-be enterprise cloud players, some have the right assets, market positioning, vision and execution to be winners while others do not. Portfolio managers will be looking for the right races AND the right horses with the right jockeys. The last few years have been tough on active management, but the next few could expose a lot of weakness in the programmatic strategies that have pressured the industry. We expect stock pickers to reign in the post-pandemic era.


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