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Ben Carlson @awealthofcs

These losses are breathtaking: Teledoc -80% Zoom -82% Robinhood -86% Peloton -88% Depression-level stuff

To say that Big Tech has been having a bad year is quite an understatement. After such a massive drawdown, it might even be possible to make a case for creating a diversified long-term portfolio composed of exclusively Big Tech stocks chosen at random at today’s share prices.

I know that I usually write about ASEAN stocks - but every once in awhile, something from outside our borders that simply cannot be ignored catches my eye. Allow me to illustrate:

At the bottom of this article, you’ll find my thoughts on the merits of these stocks as investment ideas today. But to fully appreciate why, we’re first going to have to understand the investment philosophy which makes these stocks look attractive amidst such large drawdowns - by reviewing Buffett’s initial investment in GEICO in 1976.

Click this image to expand this historical share price chart of the FAANGM stocks

How Buffett’s Investment Philosophy Applies To Big Tech Today

Inside the Investments of Warren Buffett: Twenty Cases by Yefei Lu — Click this image to buy this book from Amazon

To understand why I think US Big Tech might be presenting some seriously interesting opportunities right now, we first need to take a walk down memory lane and understand Buffett’s investment philosophy - and how it applies to Big Tech stocks today.

In Yefei Lu’s amazing book Inside The Investments of Warren Buffett, the author takes us on a journey through some of Buffett’s best investments over his 66-year career (e.g. AMEX, Geico, Wells Fargo, Coca-Cola) - by pouring through their financial statements at the time their stakes were acquired by Buffett. The goal was to try and piece together what the Oracle of Omaha saw in them at the time, based on publicly available information. The idea here is to try and reverse-engineer his decision-making process, and attempt to learn his ways straight from the horse’s mouth.

One inescapable observation that can be made in nearly all of Buffett’s “pillar” investments is that he made all these legendary investments during times of crisis. AMEX’s investment was made during the infamous Salad Oil Scandal; Buffett’s investment in GEICO was made whilst it was about to go under; Coca-Cola’s stake was bought when it was still an underperforming conglomerate; Wells Fargo’s investment was made immediately post-Savings & Loans crisis; Goldman Sachs investment was made at the height of the 2008 GFC; while Apple’s investment was made in 2016, when after saturating China they apparently had no more worlds left to conquer.

The common thread behind all these investments is that they were made during times of abundant risk (or at least perceived risk) - and clearly the majority of sellers at the time were offering buyers a discount precisely due to widely-held fears of those risks materializing. This stands in stark contrast to the notion that Buffett somehow was able to see past these risks - he did not have any superior foresight over anyone else when he acquired these stakes, as he did not have the benefit of hindsight or access to privileged information either. Any information he did possess at the time was also publicly available to all other market participants - e.g. in 2016 you could also have known that Apple was a “wonderful business”.

Rather than superior foresight, the difference in Buffett’s winning approach is actually derived from his differentiated process. Where most investors have a 0% tolerance for loss, Buffett and his cohort have a tolerance for acceptable levels of loss. I shall explain in greater detail about what these mean below - but even at this point, we can see how Buffett doesn’t have a crystal ball into the future either. Nor is he simply pursuing the lowest common denominator of investing in “wonderful businesses at fair prices” per se. If this was the case, he would have lost his edge decades ago once this investment philosophy became common knowledge.

So what do I mean by most investors having a “0% tolerance for loss”? Think about how most investors approach the valuation of their stocks. They derive a target price for the stock - and if that estimated value exceeds the current share price by a considerable margin, they consider it a Buy. This implies that you must be correct about your valuation - if you are wrong, you might as well go back to the drawing board. In fact, most investors would find that there is no point even considering the possibility of being wrong - since if you begin with the assumption that your analysis is incorrect, what’s the point anymore? This makes the valuation exercise an outcome-oriented approach - where the investor allocates all of his efforts towards perfecting his analysis through rigorous research in order to determine the correct outcome (i.e. target price).

Notice the implications of pursuing a valuation exercise this in way. As I’ve mentioned, there is a 0% tolerance for being wrong in your analysis - since if the outcome you predicted fails to materialize, all your efforts are in vain. This is why when new market developments lead to an increasing likelihood that your initial thesis has been violated, you start to panic. Recall how you felt the last time you were wrong about your stock analysis - there was likely a sense that control was slipping from your grasp as the share price moved in the wrong direction; and you started to consider the possibility of selling the position in order to regain that control. You must be correct about your analysis - being wrong is not an option. Hence, by the time you’re forced to accept that your initial thesis was wrong, volatility (i.e. temporary loss of capital) starts to look a lot like risk (i.e. permanent loss of capital) - which is when people tend to lose their courage to “hold for the long-term”.

The Story of Buffett x GEICO 1976

Now contrast this with Buffett’s approach as described above - let’s use GEICO as an example. As mentioned above, Buffett acquired his initial stake in GEICO in 1976 when the beloved insurance company was facing the threat of bankruptcy. The main problem was a cash crunch - GEICO had previously underwritten a lot of bad policies, and when the chickens came home to roost GEICO found itself facing insolvency. While its new CEO Jack Byrne eventually managed to get its insurance competitors to provide funding to GEICO and stave off bankruptcy - as they were worried state regulators would force them to absorb GEICO’s insurance policies at their own expense if it went bankrupt - Buffett had already invested in GEICO prior to Jack having gotten his competitors on board. This meant that he was accepting the possibility of a total wipeout of his initial 1976 investment in GEICO of almost $50M - as there was no way he could have guaranteed the outcome of GEICO’s competitors agreeing to fund it.

Click this image to learn more about GEICO’s trials and tribulations amidst Buffett’s initial investment in 1976 - and follow me on Twitter!

Ask yourself, would you have invested in GEICO at the time the way Buffett had in 1976? In all likelihood, the majority of investors would answer “No” - because there was no way to guarantee a favorable outcome - i.e. you couldn’t reliably predict what would happen no matter how hard you tried to analyze the situation. At the time Buffett acquired his first stake in GEICO, there was no way to put a number on the probability of its insurance competitors coming to save it from potential insolvency - which means that it was impossible to reliably estimate the probability of loss. And if you had a 0% tolerance for loss, quite naturally you wouldn’t accept such a risk of failure. A contemporary comparison is to invest in airline stocks today - you can try and analyze all you like, it is impossible to put a number on the probability of COVID-19 flaring up again with a new variant.

And yet Buffett did invest in GEICO in 1976 - whose insurance float is estimated to have contributed to nearly half of Berkshire’s historical returns, by some estimates. What was different about his approach was that he was willing to accept the possibility of being wrong in his investment thesis - and he could tolerate a loss if he ended up being wrong. However, he did limit his exposure to such losses as evidenced by how he continued to acquire GEICO’s shares throughout 1976-1980 after his initial investment at progressively higher prices - rather than buying them all in one go at the beginning, when he paid a rock-bottom average price of just $3.18 per share for his initial 15% stake of 1.3 million GEICO shares. Regardless, he was still accepting the possible loss of that initial 15% stake which he acquired in the face of extreme uncertainty if he ended up being wrong - an exposure that most investors today would still find unacceptable (similar to investing in airline stocks today).

If you’d like to learn more about Buffett’s investment in GEICO in 1976, please find the following resources for your enjoyment:

220430 Why Does Warren Buffett Make Money Buffett Derivatives Nov 2013

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220430 Geico Case Study

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Buffett’s Investment Philosophy towards GEICO - A Tolerance For Loss

So why did he do it? As I’ve mentioned above, Buffett doesn’t view the stock valuation exercise through a binary lens of being right vs. wrong. He views it through a probabilitic lens of the risk:reward ratio - or in industry parlance, an asymmetric risk:reward. Because he does have a tolerance for loss, he is willing to embrace a risk of loss as long as the potential return justifies taking those risks. Notably, this does not guarantee that he will come out on top - a positive risk:reward ratio leaves a potential loss outcome as a loose-end even by your own estimates, and such an open-ended exposure is typically undesirable to someone with a 0% tolerance for loss. However, having a tolerance for such loss allows you to let the downside go and turn around to start considering the upside - rather than feeling the need to eliminate all possible downsides before allowing yourself to consider the next step.

Let us put some meat onto these bones by illustrating the above with a real-life investment decision example. Say you were to invest in AirAsia today - where the pandemic risk can only be estimated up to an inadequate degree, despite all efforts to the contrary. This means that an investor who invests in AirAsia today will need to have a tolerance for loss - since no matter what he does, he will be unable to eliminate the uncertainty of potential loss - even in his own mind. As a result, most people would hesitate to approach such a stock even with a ten-foot pole because of that - whereas someone like Buffett would recognize his inability to estimate the downside further and then invert the question - how much upside is there?

If you’ve read my AirAsia report, you’ll know how I attempt to address its potential valuation - its current share price is RM 0.72, whereas its pre-pandemic share price was closer to RM 2.00. This means that if we can eliminate the uncertainty of pandemic risk, it would be quite conservative to estimate that the upside could be up to 300% in a few very short years. However, because the uncertainty of pandemic risk cannot be reliably estimated (i.e. high uncertainty), an investor with a 0% tolerance of loss would likely not even entertain this stock as a potential investment. Whereas someone who can tolerate losses might go on to compare the potential downside with the potential upside, since the risk:reward ratio is 1:3 despite the potential loss outcome remaining a loose-end. This is what I meant by Buffett having a tolerance for loss - as we can see in his GEICO investment above, he was willing to tolerate a complete wipeout on his investment because the upside was so immense.

Of course, this does not mean that you should take such tolerance of loss to the extreme - you can cap your loss at the aggregate portfolio level via other methods (e.g. prudent position sizing). However, the point to take home here is that within a particular stock position, having a tolerance for loss is an indisputable advantage - since it allows you to consider stocks that most investors would not even consider, and approach the research process from an entirely different perspective. Consider for instance the possibility of investing in Big Tech stocks today amidst their recent -50% drawdown - if you had a 0% tolerance for loss, would you even entertain the possibility? And yet most people can see the logic of investing in a global monopoly (e.g. GOOG) at 20x PE today - but such an investment would only be tenable if you have more than a 0% tolerance for loss.

The beauty of having such a tolerance for loss is that the process doesn’t stop there. Because you are now actively considering your exposure to the downside, you will naturally want to limit your potential loss exposure - which means that you are actually thinking about your downside. Contrast this to the average investor, who only considers the upside in their stock valuation and where the possible downside is merely an afterthought in the research process - does this sound like a better approach to valuation? By acknowledging that you have exposure to loss, you force yourself to recognize that losing money is an entirely real prospect when buying stocks - and the possibility of losing money gets taken out of your mental cabinet and gets centerstage attention. Only then, by recognizing the downside, can you start measuring the downside - e.g. asking yourself how much the stock could permanently fall by in various different possible future scenarios. (which amusingly enough is a process nowhere to be found in the DCF model)

The first advantage of approaching the valuation exercise in this fashion is that it allows you to consider many more stocks that you would otherwise not have considered - which gives you a much larger stock universe for discovery. However, the real advantage of this approach is that it allows you to consider stocks that might be dramatically undervalued - due to their share prices cratering far below their poor fundamentals - but where the chance of failure is not 0% (e.g. AirAsia today). Just as the share prices of stocks with strong fundamentals can become overtly buoyant due to excessive optimism, so too can the share prices of stocks with poor fundamentals become overtly depressed due to excessive pessimism - perhaps owing to the potential risk of wipeout. However, that also means that if their share price revert to the mean in a recovery scenario, the upside from such stocks tends to be massive - and arguably, the average yields from the latter category are higher than those from the former category.

Of course, the problem with approaching stock valuation in this fashion is that pursuing unloved stocks which are cratering in share prices tends to involve risk (e.g. Big Tech today) - and if you are someone with a 0% tolerance for loss, this might be an untenable position. But as I’ve also explained, having a tolerance for loss will allow you to consider such stocks where you otherwise wouldn’t (e.g. Alphabet trading at 20x PE despite being a global monopoly). For instance, if you have a 0% tolerance for loss, you might feel an outsized sense of uncertainty if you buy Alphabet’s stock today and their share price continues to crater - however, if you can accept a potential loss outcome (i.e. having a tolerance for loss), I find it genuinely hard to imagine how Alphabet at 20x PE is not a no-brainer investment relative to almost any other stock out there. Remember that you can limit your loss exposure via other means (e.g. portfolio management or diversification), so this isn’t akin to backing up the truck and throwing caution to the wind.

Of course, if you are an investor who has a 0% tolerance for loss, then no amount of cajoling is going to convince you to give a chance to stocks whose share prices might have cratered far below even their poor fundamentals. And if you identify as such a fellow, unfortunately that means that you will likely miss out on all these juicy opportunities as described above - and will gravitate towards seeking safety in numbers by chasing the hot stock of the day and selling with the herd. As markets are a balancing mechanism, this approach will ironically lead to embracing higher investment risk than my approach - since buying into high share prices offsets outperformance from strong fundamentals.

Whereas if you are the Buffett-type investor as described above, you will voluntarily dive into an entirely different segment of the stock universe that was previously unavailable to you with immense joy - in search of stocks with positive risk:reward ratios, rather than perceived guaranteed upsides (according to the investor). And because nobody else is doing this (because they cannot entertain the possibility of failure), you are basically a big fish in an empty pond. This is the opportunity set that value investors are frequently presented with, and why we rarely consider each other competition. (in my experience, the value investing community is unbelievably generous)

George Soros quote: It's not whether you're right or wrong that's important, but...

This investment philosophy is the essence of Soros’ quote: “It’s not whether you’re right or wrong that’s important - but how much money you make when you’re right, and how much you lose when you’re wrong". Since you are now allowing yourself the possibility of loss, you don’t need to be right before considering a stock position - what matters is the consequences of both being right and being wrong. Obviously nobody is worried about the consequences of being right; whereas you can make a best effort to limit the consequences of being wrong far in advance. And because this approach allows you to look at different corners of the stock market that most others would not even consider, the competition with other shareholders in search of attractive share prices is significantly lower - which therefore makes it much easier to find mispricings in the stock market.

Now you might be wondering, what does all of this have to do with the title of this article - i.e. Big Tech being in value factor territory? Well, I would argue that Big Tech is currently presenting us with the same opportunity set as I’ve described above - the entire sector is currently in the doldrums after its “Depression-era crash” over the past six months, and investors are staying far away from the sector amidst the perceived risks (e.g. falling cash flows, losing subscribers, etc). However, because we are have a tolerance for loss, wading into these apparently treacherous waters can actually reveal some gems - if we can assume that their share prices might have since cratered far in excess of even their poor fundamentals. Honestly, this prospect is not even difficult to imagine when you are being presented with the opportunity to acquire stakes in Big Tech megacaps at 10x-20x PE - some of the largest companies in the world.

If you’d like another idea which adheres to this investment philosophy, check out my latest AirAsia article by clicking the box below!

Value Investing Substack

✨ AirAsia (Part 3) - the Southwest Airlines of ASEAN is on sale at 12x EV/E! (or 2x PE)

Paid subscribers can join our Telegram group chat by scrolling to the bottom of this article. AirAsia’s PN17 status has nothing to do with their Merger Deficit - it is exclusively a product of their negative Retained Earnings, which in turn were contributed by their recent…

2 months ago · 2 likes · Aaron Pek

Introducing ‘FING’

As I’ve mentioned at the beginning of this article, there are four US Big Tech megacaps whose share prices I think may have fallen far in excess of even their deteriorating fundamentals. These are my affectionately-termed ‘FING’ stocks - Facebook, Intel, Netflix and Google.

As a reminder, here are their current valuations and surface-level business profiles:

NFLX at 17x PE (-68% YTD) - the world’s dominant streaming platform.
GOOG at 20x PE (-20% YTD) - a veritable global monopoly.
FB at 15x PE (-40% YTD) - another global monopoly, albeit with less sunny growth.
Intel at 9x PE (-18% YTD) - the Lockheed Martin of Tomorrow.

I’ve already discussed why I like GOOG - it is literally a global monopoly whose core business of Search is not facing any significant threats or long-term underperformance whatsoever - and yet it is currently on sale at 20x PE. I’m sure there are many ways to justify why you think it deserves that valuation - but at 20x PE, I’d argue that even Buffett would take his chances with a global monopoly with pricing power that is throwing off 20% trailing earnings growth - without any significant threat to future earnings growth in sight. For a similar albeit less optimistic thesis, I’d argue that Facebook (another global monopoly) at 15x PE deserves a look as well.

I’ve also discussed why I like Intel in a previous report - click the box below if you’d like to read up on my thesis for it:

Value Investing Substack

✨ AEM Holdings - Supplying the Lockheed Martin of Tomorrow (Part 1)

This is Part 1 of a two-part stock report on AEM Holdings. Click this link to read Part 2. Paid subscribers can join our Telegram group chat by scrolling to the bottom of this article. Value investing - according to conventional finance - is usually described as a dogmatic adherence to buying stocks at low valuation multiples…

2 months ago · 2 likes · Aaron Pek

To be clear, I haven’t really performed a deep-dive into any of the aforementioned ‘FING’ stocks yet - and my optimism is only meant to serve as an enthusiastic recommendation for you to give them a deeper look, rather than outright Buy calls. Nonetheless, you just don’t get the chance to buy a global monopoly at 20x PE everyday.

As this is primarily a blog about value investing in ASEAN stocks, I don’t intend to write about these as deep-dive paid articles - but I fully intend to find some time to do a shallow-dive into some of them as free articles one day, which you can then build on with your own deep-dives. Honestly, these valuations are flabbergasting.

In fact, I plan to do one for Netflix right now! In the upcoming few days, I will be publishing a free stock report titled “Much Ado about Netflix” - which will be taking a cursory look into their historical financial performance and attempt to guess what their future might look like. And yes, I’m aware that Bill Ackman just dumped his position in Netflix - but at 17x PE, it’s genuinely difficult to ignore.

If you’d like to get notified when my upcoming FREE report titled “Much Ado About Netflix” is published over the next few days, sign up with your email below for a free subscription! (update: click here to read!)

30 day free trial of Modern Learners Community - Modern Learners — Click this button to get a 30-day free trial if you’d like to access all the paid stock reports on this blog!

Value Investing Substack

Telegram group chat for paid/trial subscribers

Invite link to join the Telegram group chat is located at the bottom of this article. In light of adding even more value to my paid subscribers, I have created a new Telegram group chat exclusively for paid subscribers. This includes both trial and fully-paid subscribers…

5 months ago · 2 likes · Aaron Pek

Value Investing Substack NEWS

Highly curated news on stocks, economics, finance and value investing

By Aaron Pek

We also have a sister news blog for daily market news, Value Investing Substack NEWS. Click the box above to check it out!

Reach out to me at: valueinvestingsubstack@gmail.com

Disclaimer: The analysis presented on this site represents the opinion of the author for entertainment purposes only. The author is not responsible for any risk or reward resulting from the assumption of the above opinions. Please do your own due diligence and invest at your own risk.

Value Investing Substack

✨ Big Tech is officially in Value (factor…