Price is what you pay, value is what you get.
“Price is what you pay. Value is what you get”, a quote uttered famously by Warren Buffett in his 2008 annual letter to the Berkshire Hathaway’s shareholders. Price and value are two sides of the same coin. Understanding the difference between price and value is the core principle of value investing. It is also core to KeyStone’s hybrid strategy which involves buying growth & dividend growth stocks that offer GARP or growth at a reasonable price. We are not always looking for the cheapest stocks on the market, nor will we pay anything for a business – we look for a reasonable price, for a good business.
Unfortunately, particularly in the technology sector, that principle had been largely ignored over the past 12-18 months by investors chasing growth at any price and it is coming home to roost.
Let’s take a quick look at investor sentiment that has led us to where we are today. Under-communicated by the broader indexes has been the stealth crash in growth tech and risk-oriented stocks.
This chart authors an alarming story. While the NASDAQ index itself rose to the end of 2021, by the start of 2022, over 40% of NASDAQ stocks were down 50% from their highs on the year.
How can this happen? Two things are at play. Number one being the dominance of the “MegaCap-8”, Alphabet, Amazon, Apple, Meta, Microsoft, Netflix, NVIDIA, and Tesla. The combined market cap of these tech behemoths has surged over the past 10 years (including in 2021) to just under $10 trillion, giving them incredible influence on the broader indexes.
Chart created by: Yardeni Research Inc.
The MegaCap-8 now make up almost one quarter of the entire S&P 500 and over half the NASDAQ 100.
Chart created by: Yardeni Research Inc.
The result, a strong year of gains (as we saw for the MegaCap-8 in 2021) can mask losses, even significant losses, elsewhere in the index.
But why close to 50% of Nasdaq stocks down over 50% from their 2021 high?
A major theme heading up to the pandemic and immediately following has been massive capital inflow into “disruptors or innovation stocks” – stocks that promise to change the world and become the next Google, Microsoft or Apple. The problem being, while a number are excellent growth businesses, including the likes of CrowdStrike Holdings Inc. (CRWD:NASDAQ) and DocuSign Inc. (DOCU:NASDAQ), the multiples investors were willing to pay to sales and cash flow (if present) were historically high. In other names such as EV hopeful, Rivian Automotive Inc. (RIVN:NADAQ) and, in Canada, e-commerce payment enabler Lightspeed Commerce Inc. (LSPD:TSX), cash flow was negative, and price-to-sales multiples were 50-150 times plus.
Perhaps the poster child for the euphoric buying in tech disruptors is the Ark Innovation Fund, run by recent market darling, Cathie Wood. Outside of Tesla, the fund does not own the Mega-Cap-8 but rather a basket of disruptor and innovation stocks. As such, it is a decent proxy for the stealth crash. To be clear, the fund performed very well for a 3-4 year run as money piled into these stocks. But the Ark ETF has lost billions with its unit price down 34% in the last 3 months and approximately 51% over the past year. The Fund is down 36% to start 2022.
We took a quick look at the current valuations (post stealth crash) of the top holdings in the Ark Innovation Fund removing Tesla (as one of the MegaCap-8) from the equation. To give readers context, the average market PE is 23 trailing and 19-20 trailing at present. Only one of the fund’s top 12 holdings has a PE of under 30. Seven of the 12 companies do not appear to report current earnings or even adjusted earnings and while the price-to-sales multiples have decreased, historically they remain high.
Investors were buying stocks symbols (price) with little consideration for value. Remember, price is what you pay, value is what you get. Euphoric buying in these disruptor hopefuls fueled by cheap money, record stimulus and low rates has led to little value in this space over the past year and a significant correction, however stealthy it may be, is not surprising.
The market tends to remind you, that one cannot just pay any price for most stocks.
To give you an idea of how overvalued many of these disruptor hopefuls were trading at 50-150 times sales, below is a quick breakdown on the peak valuations on some of the best true disruptive tech companies over the past couple of decades.
Even in this list of true once in a lifetime investments, not one came close to a price-to-sales multiples of even 45.
It appears value is beginning to matter once again.
With that in mind, while we have continued to recommend long-term holding such as Microsoft and Alphabet, which remain at relatively reasonable valuations, we are keeping a keen eye on around 30 cash flow positive mid-to-large-cap US SaaS technology names. Stocks which have dropped in value in sympathy with the sector and may finally fall within our GARP model.
In the meantime, we are seeing some select value in unique Canadian tech and diversified names that, while not the sexiest stories on the Street, provide growth with reasonable value.
The first, Calian Group Ltd. (CGY:TSX) ($64.50), a diverse products and services company providing innovative healthcare, communications, learning and cybersecurity solutions, recently announced a solid acquisition in its IT/cyber-security division.
Calian trades with a forward EV/EBITDA multiple of approximately 11 times. We expect revenue growth of ~18% in 2022. If Calian can achieve the mid-range of F2022 guidance and we add in ~$40 million from Computex (IT/Cyber-security), at an EV/EBITDA multiple of 13 times, we see fair value at ~$76.
The second, TELUS International (TI) Inc. (TIXT:TSX) ($32.45), a digital customer experience innovator that designs, builds, and delivers next-generation solutions, including AI and content moderation, for global and disruptive brands (I see innovator & disruptive in that description), just reported solid FY2021 growth numbers and a solid growth outlook for FY2022.
TI trades at 22 times FY2022 expected earnings and with an EV/EBITDA of approximately 13x. While we expect EBITDA margins to moderate in the first half of 2022 as the company ramps growth investments to support anticipated organic growth acceleration next year, margins should pick up by the end of 2022 and still remain at the top end of its segment. Our fair value for the stock is $44 over the next 12 months with an estimated holding period of 2-3 years. Following a slight disappointment in terms of margin guidance, the stock may weaken near-term, which should be an opportunity with revenue and earnings expected to grow 17% and 21% respectively in the coming year without including further acquisitions.
Finally, we will highlight a unique cash rich, but higher risk business which continues to perform well from our Canadian Small-Cap coverage. Dynacor Gold Mines Inc. (DNG:TSX) ($3.20), has seen its share price jump over 75% over the past year powered by tremendous growth. The company is engaged in gold production through the processing of ore at its modern mill in Southern Peru purchased from the ASM (artisanal and small-scale mining) industry.
FY2021 revenues jumped 93% to US$195.9 million or CDN$245.6 million for the year. We expect earnings to exceed guidance of between $9.0 to $9.5 million (US$0.23 to US$0.25 per share). Dynacor’s shares trade at just 8 times current year’s expected earnings. FY2022 guidance is expected shortly, and we expect further growth and the potential of another dividend increase in 2022 after two significant increases in 2021. The stock currently yields 3.15%.
Dynacor holds a strong balance sheet with US$17.8 million in cash and no debt to fund expansion at its existing plant in Peru and geographic expansion. Management intends to expand its processing operations in other jurisdictions (West Africa or other Latin American Countries are options) over the next 3-5 years. We maintain our SPEC BUY rating on the stock with near-term fair value in the range of $4.00-$4.25 – a figure we expect to update through FY2022.
Ryan Irvine is the founder of KeyStone Financial an independent financial research firm established in 1998. KeyStone provides BUY/SELL reports on profitable growing Canadian & U.S. growth & dividend growth stocks to help Canadians construct simple 15-25 stock portfolios. More information found at: www.keystocks.com or 1-888-27-STOCK. Disclosures: KeyStone or employees own positions in GOOG, MSFT, CGY, and DNG. The information provided is general in nature and does not represent investment advice. Every effort has been made to compile this material from reliable sources; however, no warranty can be made as to its accuracy or completeness. Before acting on any of the above, please consult an appropriate professional regarding your particular circumstances.