How not to pick stocks

0:05Pushkin. Every year on the Unhedged newsletter, myself and Robert Armstrong, we pick stocks. And in 2022, we did a pretty good job. Last year, though, 2023, we really screwed it up. Today on the show, what went wrong last year and how we're going to get it so, so right in 2024. So right. So right. This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I'm reporter Ethan Wu here in the New York studio, joined by the man who picks the stocks, the good stocks, the ones that go up, Robert Armstrong. I love the ones that go up. We avoid the ones that go down, pick the ones that go up every time.

0:43Not last year. That was the problem. Not last year. Last year, I think the metaphor I used is we did not crash the car. We loaded the car with dynamite, drove it off a ski ramp, and landed it in an active volcano. That was my metaphor for our stock picks. We were in the bottom, I believe, quintile of... So there were a few hundred FT stock pickers. We were in the bottom quintile of total respondents. And among FT journalists, we were dead last. We ran the numbers on just how bad we did. And if you had taken the inverse bet to us, if you had bought the inverse unhedged ETF, you would have been up 40 % in 2023.

1:22More than double the S &P 500 performance, which really in itself is an accomplishment. I know. They should have. We should get paid for that. That's rare performance. Yes. So let's go through the carnage. Yes. One corpse at a time. First terrible stock pick, which I will take full credit for, was short Netflix. Here is my view. There is going to be a 2023 consumer recession. Netflix is a very good company, but the streaming video space is crowded with competitors. There's going to be a squeeze. It's going to get hurt. Opposite happened. Consumers have oodles of money, added subscriptions. Netflix thrived.

2:02Armstrong blows up. The stock was up around 60 % in 2023. The horror. Okay, moving on. The second one we got totally wrong, and I'll take credit for this, was short Coinbase. We thought, well, it airs out of the crypto balloon. The Fed is shrinking its balance sheet. There's less liquidity in the system. If and when there's a recession, it's going to be the next leg down in crypto. And the opposite happened. There was actually a bit of a pickup in liquidity almost, more interest in Bitcoin. Yes. The price doubled last year. And so Coinbase stock 3X. And we should note that the winner, Kadeem, our colleague who won the stock picking contest, I think he owned like all Bitcoin miners.

2:44Like that was the pick that actually won the contest. He bought the dip in crypto. Yeah. Our third short. And this one was a little more subtle, ended up being a big lesson for a lot of people markets. Short Pulte Group. What is Pulte Group? Pulte Group's a home builder. We've talked about this on the show before, but I'll just run through. This was a legit screw up, not just of the recession call. We thought interest rates going up, housing affordability down, pricing pressure on home builders. What happened, though, is that because rates went up and everyone who has a mortgage at a low rate, like a legacy mortgage, just decided not to move.

3:26because they're like, if I move, I'm going to go from paying a two and three quarters mortgage to a 7 % mortgage. No way. I'm staying in this house forever. That means the only houses that are available to buy are new houses. And Pulte Group, which makes new houses, has a great year. Sound of car falling off cliff and crashing on the ground. And more broadly than Pulte, home builder stocks in general were one of the big trades of 2023. Warren Buffett's Berkshire Hathaway got into that trade. There was tons of interest in it. I think it wasn't broadly expected that this would happen, ended up being a really interesting trade.

3:58Also, lesson there, it is very, very hard to short any company that has a structural tailwind. The fact is we don't have enough housing units in the United States. Whatever the particular circumstances of a particular year, you don't want to get in front of not enough houses in the form of betting against a home builder. I won't be doing that again. So we bet against three of the biggest winners of 2023. And so that meant that the losses were so bad in the short side of our portfolio that our long picks, which were fine, just weren't able to offset it. We thought, okay, we don't want to be 100 % short in case something goes wrong.

4:37Let's buy two nice, safe, very high quality companies, which we did in Domino's and Hershey's. Nestle. Oh, I'm sorry. Yeah. I was saying American chocolate. Yeah. I apologize to the nation of Switzerland for that mistake. We buy these two very safe companies and that way if the market goes up, we'll have some protection. That was a mistake in itself. In an expansion, it's not high quality, safe, defensive names like Domino's and Nestle that rise. It's risky companies, right? It's growthy companies. So these longs, Nestle was kind of flattish. Domino's was sort of up with the market. They didn't really offset the damage we did with our short picks.

5:22Yeah. So that was the anatomy of the carnage in 2023. Rob, what do you feel like we learned? First of all, no regrets. It's a stock picking contest. You have to shoot the ball from half court if you want to have a chance to win. And sometimes when you shoot the ball from half court, you miss. Sometimes you're Steph Curry, though. Sometimes you're Steph Curry. Sometimes you miss. So I don't regret, of course, packing the portfolio with risk. What I do regret is betting against companies with secular tailwinds. That's a losing proposition. And I regret not understanding what should have been an obvious dynamic in the home building industry.

6:06I don't regret the Bitcoin bet at all. Yeah, that could have gone either way, I think. Yeah. This year, though. This is the year. This is the year. Get your bets in on unhedged, folks. We're going up, up, up, up. The inverse unhedge ETF is going to have a terrible year in 2024. Okay, so now in actual stock picking, you don't want to make macro bets, right? It's not smart because any insight you might have into broad trends in the market or the economy, any insight like that is going to be a multi-year trend. It's a coin flip whether the trend is going to take hold in a given year. Even if you have a one-year stock picking contest, you might have a good long-term macro thesis and you might stick with it, but that's a multi-year bet.

6:48Yeah. But we're going to make a bet anyway. We're going to make a bet on a style. Yeah. That style, it's called GARP. GARP. What is GARP? Which is not the movie or the John Irving. It is growth at a reasonable price. So we don't know what's, we're acknowledging that we don't know what's going to happen in the macroeconomic environment this year. So instead what we are doing is saying what style of stock is well-suited for an uncertain and volatile macro environment. Well, we like stocks that are inexpensive, but have a little growth anyway. Yeah, yeah. And expensive stocks, actually, growthy, fancy, techy names have done really well for the last couple of years.

7:31So we hope that changes and value comes in a little bit. And we hope that under any circumstances, owning companies that grow some will help. So we're giving GARP a try this year. Giving GARP a chance. And the hope is that if you buy companies with growth potential at a reasonable valuation multiple, usually that's going to reflect some kind of issue that they have that the market has priced in, right? There's a reason that the growth is not trading expensive, it's trading cheap. Yes. And we tried to take, you know, in the limited time we have, take a look at these companies and say, well, maybe the worries are a little bit overpriced and there's more upside here than the market's given credit for.

8:07Okay, GARP, growth at a reasonable price. What do you got, Rob? First pick, Dollar General. You put it really well. You want to find a company that is cheap for a reason, but you think the reason might go away. And this is a company that's in a restructuring. It has a new management team. It did an acquisition a few years ago that has not gone well. It had problems with inflation during the crisis. So the stock, which traditionally boasts great growth, the dollar store model is a great growth model that has generated great returns for investors over the long term. I'm hoping the new management team can turn this thing around.

8:47Inflation becomes less of a problem. The problems from the acquisition a few years ago of family dollar get better and the stock goes on a rip. Yeah. Well, another stock that we picked that might benefit from a lower inflation environment, General Dynamics. Yes. Well, also, it's a defense stock. You may not have heard, Ethan, but the world is going to hell in a handbasket. A lot of wars right now. So, you know, they're a defense and aerospace firm. You know, that will help. They're just, it's an extremely cheap stock relative to its earnings. It's been a slow grower, but expectations, partly because of the hostile environment we're living in this world, growth expectations for earnings are pretty good over the next couple of years.

9:30I like the idea of owning a defensive stock and that one, the expectations for growth are pretty good. So this Dollar Tree, General Dynamics, one that I picked was Expedia. People might know this, they got ads everywhere. It's one of these consumer travel companies. It's got a pretty modest PE ratio given how much profit growth it's had, which is a lot. And the reason for that in part is it's a competitive industry. There's a lot of consumer travel companies, a lot of people that want to sell you plane tickets and hotel tickets and so forth. What Expedia has going for it though is a really good cost-cutting strategy in an industry that's growing.

10:03So they've been growing profit margins really substantially over the past couple of quarters. If that continues, they've got a big digitization push that's working. The travel market's not really slowing down. Recession would derail this pick for sure, but there's not that much good news priced in for Expedia. And there's a lot that could go right on the cost side. And there's plenty of good news to still come in the travel market, assuming the economy doesn't slow down. So that's Expedia. I like it. My next pick was Everest Group, which is a reinsurer. So they are an insurance company for insurance companies.

10:35They do have a primary property casualty insurance unit, but mostly their reinsurance. The reason I like that stock is reinsurance companies are always cheap because in a sense, it's just capital, right? It's like a kind of bank or a reverse bank. So it's cheap for the same reasons banks are. But it's been a bad business for a couple of years because too much capital rushed into reinsurance. And because in the last five years, we've had some bad catastrophic events, hurricanes. Now, prices in the industry have gone up because of those hurricanes. Whenever there's a bad event, what happens is the insurance companies take a whipping and then repricing season comes and they go to their customers and they say, you remember that hurricane last year?

11:20We got to raise our prices. So pricing is firm. Capital has left the industry. So it's a little bit less competitive. And because I control the weather with my mind, I know there aren't going to be any hurricanes this year. So between those three factors, I think we're in very good shape with that one. We're short hurricanes. Yeah. Yeah. Basically for short hurricanes. Okay. Pick five. And this is one that's already been kind of paying some dividends for us. Cigna, the health insurer. Cigna, very boring company. They basically are a commercial health insurer in the United States. You work for a big company.

11:55It's like UnitedHealth or Cigna is probably one of your insurers. It's a good growth business because basically healthcare prices go up and health insurance Its premiums grow with healthcare costs. And Cigna is the cheapest of the group. It's the cheapest of the group, however, interestingly, because it is not involved in government health insurance. It's not involved in Medicare Advantage. Right. And so these are plans that are determined both by the government and the private market. And the private market. And Cigna has been small in that business compared to competitors. That business has been growing well.

12:35but it's not having a good year this year. So while its competitors will be suffering a little bit because the Medicare Advantage business isn't doing that great, suddenly Cigna's lack of that business looks like a virtue. And the stock's been up so far this year, fingers firmly crossed, very cheap stock, some earnings growth. And in the case where it's a bit choppy out there in markets, a reinsurer, a health insurer. I think these are a defense company. I think these are going to do pretty well. And in a more lively market, an up market, a good economy, I think Expedia is going to could do really well.

13:16Yeah, absolutely. So there you have it. Everest Group, Cigna, Dollar Tree, General Dynamics, and Expedia. These are our GARP picks for 2024. Now you'll notice None of them are to the moon. Yeah, that's what I'm worried about. That's what I'm worried about is that this portfolio, maybe we were scared because of last year's disaster. But what I'm worried about is we don't have enough risk in the portfolio. Maybe we were too timid because we took big risky bets last year. We got completely smoked. And this year, do we have the stuff in the portfolio that wins a stock picking contest? Like I wouldn't mind owning this portfolio in my actual portfolio.

13:57And that suggests to me that it can't possibly win a stock picking contest. It's going to be a very specific set of circumstances in which this portfolio wins. And it will be there's a strong shift from growth stocks to value stocks in terms of investor preferences. And probably the economy has a slowing pattern in the second half of the year. We're not seeing that now, but those are the two things where I think we might do pretty well in the contest. All right. growth at a reasonable price. Listeners, if you have happened to enter the FT 2024 stock picking contest, please email us. Let us know what you picked.

14:35Ethan.WuWU at FT.com. Okay, and let us say together at the end here, this is not investing advice. Not investing advice. Not investing advice. Past performance, as I often tell my wife, is not predictive of future performance. In this case, a good thing. A good thing. In this case, a good thing. All right, Rob, we'll be back in a moment with Long Short.

15:02Welcome back. This is Long Short, that part of the show where we go long a thing we love, short a thing we hate. Rob, I'm Long Disney. Whoa! We've talked about on the show their problems with activist investors, the slumping stock, the streaming losses, etc., etc. Everyone's bored of Marvel movies. Everyone hates Marvel movies. But they just had an earnings call yesterday. Bob Iger came to play. He came with like seven announcements of new stuff that Disney's doing. They've got a partnership with Fortnite, exclusive streaming rights to a Taylor Swift movie. They're buyback, dividend, all this crazy stuff.

15:33And they're reducing the streaming losses. Yeah, that's the real story with Disney, right? It is. The streaming losses. And they get those under control. It's a different company. I mean, Iger's come around in kind of record time, started engineering some kind of turnaround. Obviously, we'll see how it eventually turns out. But the stock liked the earnings call yesterday. I'm feeling good about it. Yeah, right on. Too bad we don't have another stock pick. Yeah. We should have gone long, Disney. Okay, Ethan, I am short the final stage of in-shittification. And I use that word because it was in the FT today.

16:06The tech critic and gadfly, Corey Doctorow, had a piece in our paper today called In-shittification is Coming for Absolutely Everything. And this is a process in-shittification in which social networks inevitably become terrible. And he says here, it's a three-stage process. First, platforms are good to their users, Twitter, Facebook, whatever. Then they abuse their users to make things better for their business customers. Finally, they abuse their business customers to claw back all the value for themselves. Then he says there is a fourth stage, the networks die. I think the networks never die.

16:45I think inshittification can go on forever. The network effects are so strong that it doesn't matter. Twitter has gotten way worse. Doesn't matter. We all still use it. However bad the social networks get, they will continue to be good businesses. Infinite inshittification. I'm long, I'm long. You're long infinite inshittification. All right, Rob, thanks for being here. We'll have you back soon. And listeners, we're back in your feed on Tuesday with another episode of Unhedged. Catch you then. Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein.

17:23We had additional help from Topher Forheads. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn, and Natalie Sadler. FT premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Ethan Wu. Thanks for listening.

17:54We'll be right back.