Nicholas Ward

When it comes to portfolio management, there are certainly many ways to skin the cat with regard to reaching one’s financial goals. This is why it’s difficult to write about equity trades; there are simply too many variables at stake: current net worth, income/savings levels, debt, time lines to retirement, life expectancy, and goals within retirement, just to name a few. Because of this, it’s rare that any two individuals will ever be in the exact same boat. When talking about the trades I make, I’m constantly saying that I’m not interested in doing what’s right for anyone else, just what I believe is right for me and my family, financial speaking. With all of this being said, I do think that there are two basic sins that all investors should seek to avoid: fear and greed. These are the two predominant forces that move markets. Yet, they’re both based in irrationality and increase risk, so it’s my belief that investors who can avoid fearful or greedy temptations (or at least manage them) will be putting themselves on the road to success.

With this in mind, I come to my most recent trade: the sale of ~32% of my Amazon (AMZN) stake for $1415.00/share. Amazon is a fairly unique company in the markets, especially with regard to fear and greed. Typically, I only invest in companies whose underlying fundamentals paint the buy and sell pictures for me fairly clearly. As a fundamental value investor, I’m able to take subjectivity (and therefore, irrationality) out of the equation most of the time by relying on the numbers. This is comforting to me; the combination of historical data, present data, and the collection of forward looking estimates by company management teams and highly qualified individuals can go a long way towards removing speculation from investment decisions. Sure, no one has a crystal ball, and the past doesn’t represent future outcomes, so there is always a certain degree of speculation involved with equity ownership; but, for the most part, I feel good about my process of using data to eliminate guesswork, which has lead to above average returns over time.

Well, Amazon doesn’t really fit into my process very well. This company doesn’t prioritize present profits like just about every other company that I own, but instead, market share growth. I don’t have any idea what sort of discount I should give to Amazon when looking at future cash flows because I don’t think that Jeff Bezos and crew operate using traditional IRR/NPV mindsets (or, their time lines are so long that it doesn’t make much sense to attempt to do a discounted cash flow model because there is simply too much speculation involved in looking out decades rather than years). I’ve heard it again and again from conservative value guys and gals that they wouldn’t touch this company with a 10-foot pole. Sometimes, I don’t blame them; I mean, we’re talking about a ~$700b market cap company with sales of ~161b during the trailing twelve months, but a net income of only ~$1.9b. In other words, we’re looking at net margins of ~1%. Sure, many believe that Bezos can turn of profits whenever he’d like, and to a certain extent, I’m a believer in just about anything that Bezos sets his mind to, but at the end of the day, investors have to realize that’s a highly speculative notion.

No, Amazon doesn’t trade on fundamentals, but instead, sentiment and momentum. I know certain investors try to justify share price growth with P/sales or P/cash flow growth %, but I don’t see it. Even after its ~12% decline since 52-week highs set at ~$1615 in earlier in March, AMZN has posted YTD returns of 22%. Looking out a year, AMZN is up ~65%. The company’s sales are up ~18.5% during the trailing twelve months, but EPS is down about 20%. Net income and FCF/share are also down slightly. Long-term debt has increased significant; the outstanding share count has continued to trend upwards. Don’t get me wrong, Amazon is becoming a leader in a wide variety of secular growth markets (eCommerce, cloud, AI, and automation) and any one of these markets could eventually justify the company’s current market cap; however, we’re looking out decades down the road with that sort of statement. I’ve said before that Amazon probably has the longest growth runway of any company that I follow in the market. This is why I own it. However, when a stock trades on momentum, and that momentum shifts, it can lead to disastrous results for current shareholders, which is why I decided to trim a roughly 1/3 of my exposure due to recent cracks that have formed in AMZN’s armor, locking in ~43% gains on shares I bought last June in my IRA for $997.75.

This decision to trim Amazon follows the recent liquidation of my Facebook (FB) stake at $172 (locking in ~16% gains) and the ~25% trim of my Alphabet (GOOGL) position at $1031 (locking in ~40% gains). Unlike Amazon, the latter two F.A.N.G. names here actually have strong fundamentals that make it easy to justify their current share prices, but the Cambridge Analytica issue has led me to believe that legislators are going to get involved with the big tech names regarding big data and personal privacy and these regulations could create significant headwinds for future growth estimates. As I said in the piece I wrote regarding my Facebook sale, without a dividend or meaningful shareholder returns, it’s difficult for me to hold high growth names like this when they’re facing potentially secular headwinds.

Do I think that any of the F.A.N.G. names are going to disappear? No. Do I expect all of these names to continue to post double digit top-line growth? Yes. Do I think they will continue to disrupt traditional players in their industries and take market share? Yes. This is why I didn’t sell my entire positions when it comes to AMZN and GOOGL, but instead, only trimmed a minority of my shares. However, these names all trade on forward estimates and if these fall, so will present multiples, and in a volatile market environment, I’d rather take steps to protect profits rather than put them at risk (remember, unrealized profits can turn into losses if you’re not careful).

Facebook was an easy sell decision for me because while the rest of the F.A.N.G. names are likely going to be effected by the public sentiment uproar against these big tech companies, Facebook is going to be the poster boy of reform. These companies have basically become more rich and powerful than the world’s leading governments at this point and I’m sure that governing bodies don’t like this and will do what they can to reign them in in an attempt to restore the balance of power in their favor. I’m a believer in free markets, but I’m also a cynic when it comes to the power grab that is politics and there seem to be a variety of levers that governing bodies could pull when it comes to regulation on these big tech leaders. Look, the tweets from the POTUS that are seemingly signaling the AMZN sell-off aren’t anything new, the market is just viewing the F.A.N.G. names through a different lens now: regulatory and political headwinds seem more real now than ever.

So, getting back to my opening paragraph, by selling and/or trimming my F.A.N.G. is a measure that I’ve taken to eliminate greed. Sure, there was some fear involved as well (I didn’t sell at the highs, willing to ride the momentum train with these stocks until I sense a turn in the tracks). When I looked at these high growth/high multiple positions that didn’t contribute to my passive income stream, I realized that locking in some solid gains in the present as a responsible step to take. In doing so, I am acknowledging the opportunity cost of leaving potential massive profits on the table with the shares that I sold; however, I’ve always said that my goal as an investor isn’t to become a billionaire, but instead, meet my financial goals. I like having exposure to the best in breed, disruptive growth companies in my portfolio which is primarily filled with DGI holdings, but in this late cycle environment, I’ve decide it’s in my best interest to have a short leash with these types of companies.

I don’t plan on selling anymore AMZN or GOOGL shares anytime soon now that I’ve lowered my risk to more acceptable levels. My cash position is at its highest point in more than a year now and while I’d love to put these funds to work in opportunities that augment my passive income stream, I also wouldn’t be opposed to buying back these high growth tech names if/when their valuations fall to the point where I think I have a wider margin of safety.

Right now, I’m sort of sitting on my hands, watching the macro scene with regard to interest rates, the narrowing yield curve, geopolitical issues, and the constant circus that is Washington D.C. these days. Q4 GPD was just revised to 2.9%, which is solid. Unemployment is low, wage inflation is starting to take place, and ultimately, this is a good thing for the domestic economy. However, productivity growth has been hard to find throughout this trend of lower unemployment, which presents a problem. I think we're entering into a new era of economical growth and we’re about to find out if its possible for the U.S. economy to post above average growth without the growth of workers (something that it's never really done before). Increased productivity is going to have to come from elsewhere and while I’m sure that autonomy can fill these shoes over time, there will certainly be growing pains there as workers (especially in low-skilled jobs) are forced to retool themselves to operate in a digitized world.

I expect the FED to sort of counterbalance a lot of the benefits from tax reform and this, combined with some of the trade rhetoric gives me cause for concern. The front end of the yield curve is rising but global central banks seem to have a pretty strong hold on the long-end, keeping that steady. I’m worried about the yield curve inverting. And most of all, I’m worried about the Mueller investigation/the potential for the POTUS to fire Mueller, creating a major democratic issue that could end up being the black swan event that so many have been calling for. All of these macro events are shrouded with speculation, I realize this, but this current bull market run is already one of the longest in modern economic history (so long as the status quo continues, the current expansion will turn 10 years old this July). So late into a cycle, greed could be potentially harmful to the wonderful gains that anyone invested in equities over the last decade or so should have experienced. I still have ~85% of my savings invested in equities because of the earnings tailwind that is associated with lower corporate taxes, but I am more nervous now that I’ve been in my relatively short investing career. Time will tell if these worries are worthwhile, but in the meantime, I’m happy to take some risk off of the table and wait for some of these potential headwinds to sort themselves out.

Disclosure: I am long AMZN and GOOGL.