Today, I’ll go over all the details and follow up with a quick investment pitch on Ulta Beauty. In fact, it won’t be my pitch today—it will be Shawn’s.

Shawn is an incredibly smart investor, and from now on, he will join me in creating investment pitches each week.

I’m confident his pitch will demonstrate just how savvy an investor he is.

If you’re new or haven’t been following the latest updates, here’s what to expect in the coming weeks.

Starting This Week:

This investing platform, The All-in-One Investing Platform, will rebrand/integrate as The Intrinsic Value Newsletter.

Starting this week, you’ll receive a new company pitch every week!

You can choose how to consume it:

1. Deep-Dive Business Breakdown

I love learning about new businesses and industries—their unique dynamics and how they operate.

When you research an industry or company in-depth once, revisiting it later requires only a fraction of the time to grasp the key information.

If you enjoy this approach, you’ll appreciate the deep-dive versions of the company breakdowns. You can listen to them every Sunday on Spotify, Apple Podcasts, or YouTube.

2. Short-Form Investment Pitch

Some people prefer short-form investment pitches. If that’s the case, you’ll love the 5-minute investment pitches accompanying every podcast episode.

You don’t need to sign up anywhere—you’ll find them in your inbox, just like this email.

Don’t be confused when emails are no longer titled "The All-in-One Investing Newsletter." From now on, they will arrive in your inbox as the "Intrinsic Value Newsletter."

Other than that, nothing changes. Expect even more high-quality research!

Shawn’s Ulta Beauty Pitch will give you a preview of what these pitches look like.

Circle Community and Exclusive Content

Paid subscribers are finally receiving the major update that has been in the works for quite some time.

In two weeks, everyone will be able to join the Circle Community, which Shawn and I recently set up.

It will be 100 times easier than before to discuss investments, post company updates, and stay up to date with our portfolios.

Exclusive Feature: Video Calls with Top Investors

One of the most exciting features is still to come: Video Calls with some of the industry's most successful investors. (I’m afraid, we won’t be getting Buffett, though…)

As you can imagine, securing high-quality guests for the show takes time, so give us some time here.

Regular calls with Shawn and me will be available shortly after the launch. As mentioned before, I’d love for everyone to attend live, but if you can’t make it, all calls will be recorded for you to watch later.

No one will ever miss out!

I know I’m repeating myself, but I’m truly excited about starting this new journey!

Last Chance!

I’ve mentioned before that these communities are typically priced much higher than my current platform. However, I wanted to ensure that all existing subscribers keep their current pricing.

That means every current paid member will have full access to the platform and all its features! Once we’re ready to launch (in the second or third week of March), I’ll send out the Circle invites.

After that, the community will be temporarily closed. When it reopens, membership will be priced at approximately $100/month.

If you want access at the current $16/month rate (with an annual subscription plan), this is your last chance to lock in that price!

Last Chance!

ULTA: A Beautiful Compounder

To any stock investor, compounding is a thing of beauty. Bonus points, though, if your compounder is literally beautiful.

Enter, Ulta Beauty 💄

For any U.S. readers who grew up in the suburbs like me, it’s a company you’ve probably seen frequently in shopping centers. If you’re like me, you also probably have women in your life, from daughters to mothers, cousins, co-workers, and friends, who love Ulta and dragged you along to visit. Or maybe you happily visited yourself.

That’s the, ahem, beauty of Ulta — it’s a well-established cosmetics retailer that appeals across age groups, income, and ethnicities. It’s truly a universal one-stop shop for beauty, wellness, and self-care needs.

And the reason we’re talking about it today is because Ulta’s impressive track record in generating returns on capital is more than enough to make any investor blush. Yet, interestingly, its stock has only gotten cheaper in the past year.

More below on Ulta’s business, valuation, and whether it will be added to The Intrinsic Value portfolio me and Daniel are building each week in this newsletter, in just a few minutes to read.

— Shawn

Right off the top, I have to ask myself — is this really in my circle of competence?

Ulta is a beauty retailer, and while it definitely does have male clientele, I’m not one of them. That said, I grew up going to their stores, tagging along with my mom, or, as I was older, with friends, especially since there was one right across the street from my high school.

The people who like Ulta, LOVE Ulta. Obviously, not everyone who goes into the stores feels that way, but it has a core audience of what management refers to as “beauty enthusiasts.”

For these people, beauty is a form of unique self-expression, a tool for wellness and self-care, and a hobby as much as anything else.

They like to visit the stores frequently, chit-chat with associates about the latest trends in cosmetics, skincare, and hair care, try out and discover new products, or get their hair done at the in-store salon.

These are people who bought boatloads of Ulta’s products during pandemic lockdowns when they couldn’t even go out of the house because they like to smell good and look good for themselves, not necessarily for anyone else.

A testament to this dynamic is that Ulta’s loyalty program has over 44 million enrollees, with 95% of the company’s sales coming from these loyalty program members.

Competitive Advantages

So, what makes Ulta unique? What is its “moat”?

In short, Ulta’s advantages come from being the only retailer that caters to the full spectrum of customers, offering both mass-market products and high-end, “prestige” products and everything in between.

In an industry that was defined for decades by rigid social norms, when high-end brands very strictly controlled where and how their products could be sold, Ulta bridged that divide, successfully convincing premium brands that it is, in fact, okay to not only be in the same store as drug-store beauty products, but they could even share shelf space together.

Three decades later, Ulta has strong relationships with hundreds of brands, ensuring that not only do they always have the widest selection of products but also that they’re on the cutting edge of the industry, often working with viral new brands that are looking to sell in stores for the first time.

The novelty of its store layout (merging high-and-low-end products), years of relationships with leading brands, and a treasure trove of data on loyalty members all combine to form what, by all economic measures, is a sizable competitive moat.

While Amazon destroyed many retailers, Ulta’s growth only accelerated in the 2010s as its e-commerce business scaled up alongside its store footprint. At the same time, while Sephora has also boomed in popularity, they avoid competing directly with each other in some ways.

LVMH, one of the world’s biggest luxury companies that owns brands like Louis Vuitton, also owns Sephora, so naturally, their products are more expensive and focus on the prestige category, whereas Ulta is a universal beauty retailer.

Additionally, Sephora is typically based in more urban areas, particularly in traditional shopping malls with department stores, whereas Ulta’s are suburban — you’re more likely to find them next to a Nordstrom Rack or Dick’s Sporting Goods off the highway.

Impressive Track Record

But let’s look at the numbers involved here for Ulta. On average, Ulta has grown revenue by 14.5% per year over the last decade and 9.8% per year in the last five years while generating a very impressive 50% return on equity with no debt beyond the long-term leases for its stores.

Over this time, Ulta has consistently compounded returns from growing net income by 17.5% per year from 2014 through 2024.

Yet, on average, it only reinvests around 27% of its earnings to produce this growth, using the rest primarily to repurchase stock. This can be a wonderful thing for shareholders, as excess cash is used to reduce the number of shares outstanding, increasing the remaining shareholders’ stakes in the company.

To reinvest so little and still grow profits so much is a tribute to how profitable incremental investments for the company are — either from store remodeling or expansions.

And what I like about Ulta is that, while so many companies talk a big game about doing buybacks, Ulta really has done them at scale for most of the last decade, buying up billions of dollars worth of shares in the open market (the buyback yield has crawled up over the last few years, from 3% to as high as 7%.)

Who knew a beauty retailer could produce such wonderful results?

Despite this strong backdrop, Ulta has fallen out of favor with Mr. Market, who now offers shares at a price-to-earnings ratio of ~17. In the last few years, its P/E ratio has been more than cut in half, generating a major headwind for stock returns.

Based on how the company has compounded earnings per share, both from business growth and share buybacks, it should have delivered a 20%+ CAGR over the last decade. Yet, due to the compression of its valuation multiples, the stock’s 10-year annual returns are closer to 11.5%.

In part, Mr. Market has soured on the company simply for a lack of patience. After years of unexpectedly strong growth during and after the pandemic, Ulta hit some road bumps in 2024 that are expected to extend into 2025, and there’s nothing short-term investors hate more than earnings misses.

Yet, Ulta has fended off Sephora and Amazon for decades now, and I don’t think the competitive landscape has dramatically changed for the worse. Ulta is an extremely well-run company, and I’m honestly surprised at how quickly sentiment has turned on it.

To me, I see a company with a powerful brand that’s understandable and operates in an industry that’s never going away. I also see a company with a strong track record of very profitable expansion; I’m more than happy to snap up shares at a relative discount while keeping an eye to the long-term.

Valuing A Beautiful Business

Before I get too far ahead of myself, let’s look at Ulta’s valuation and consider the range of plausible expected returns it can generate for shareholders.

There are two ways, besides accounting chicanery, to grow earnings per share: Earn more net income or reduce the number of shares outstanding.

If a company earns $100 in profit and has 100 shares, then it earns $1 in earnings per share. For it to reach $2 in earnings per share, it would either need to double its profits ($200/100 shares), buyback half its stock ($100/50 shares), or some combination of both approaches.

Ulta has been a master of this, compounding its net income each year while also buying back 3-7% of its outstanding stock in a given year. Thus, it uses both levers to grow earnings per share.

If we very conservatively assume that net income falls from growing at nearly 18% per year to just 2% for the company in the next few years — in line with inflation — while the company’s share count continues to decline by, say, 4% per year (about the average annual rate over the last decade), that alone would deliver a roughly 6% annual return to shareholders, assuming the P/E ratio remains flat.

That’s nothing to write home about, but that is not a bad outcome at all as sort of a floor for our expectations.

More realistically, even if net income is down in 2025, this is still a company that, on a 5-year+ horizon, should be able to grow profits by 7-10% per year. Again, this is around half the rate at which they’ve grown profits in the last decade.

So, assuming no change in the P/E and slowing but still meaningful profit growth, combined with its large share repurchase program, should generate returns of 10-15% per year (7-10% from growing net income and 3-5% from reducing the share count).

To me, that is a very satisfactory outcome, and I would not be surprised at all if earnings growth came in above that, if the P/E ratio grew again from 17 to 20 or even 22, and/or if they bought back an even higher percentage of stock, all of which would be further tailwinds for returns.

But you can play with my model here to see how changing growth, buyback, and P/E assumptions change the 5-year expected returns.

Given that Ulta is only located inside ¼ of Target’s stores, despite a strategic partnership with the company to include Ulta mini-stores in its locations, doubling its presence in Target alone would be a significant growth opportunity. This is to say nothing of the company’s plans to add another 200-300 stores across the U.S. and even expand into Mexico.

As such, I really don’t think I’m being aggressive at all with my assumptions here, and accordingly, at roughly between $400 and $430 per share at the time of writing, I do see Ulta as likely trading at a discount to its intrinsic value and, thus, being attractive to long-term investors willing to ride out some short-term storm clouds around its business.

Risks & Final Decision

While I do find comfort in the company’s track record of operational excellence, I also believe, as mentioned, the company’s buyback program provides some further cushion, too.

That said, I can see this investment going south in a few ways. Namely, there’s no guarantee the P/E ratio will remain flat, and if earnings growth flatlines, the P/E ratio could fall to 12 or lower, which would destroy any price returns.

If profit growth is truly going to stay suppressed — not just on a one or two-quarter basis but over several years, which would be more devastating, it would likely be from a broader economic recession or a race to the bottom against other beauty retailers.

Thus far, profit margins have mostly stayed intact, so it’s not clear to me why competitive pressure would seriously erode margins if they haven’t already, beyond the modest declines we already saw in 2024. So, to me, the bigger concern is just a general downturn in the economy, which is inevitable, and as a business that relies on discretionary spending, Ulta would be in some trouble.

Still, recessions do not last forever, and compared to Sephora, where Ulta offers many cheaper cosmetics, I’d think the company is comparatively positioned to hold up well. The pandemic was a very abnormal recession, but Ulta did hold up firmly then and used that period to dramatically scale up its website sales and e-commerce operations.

So, I feel good about Ulta. This is not a get-rich-quick stock, but it is one where, with conservative assumptions, I think I can earn a return that’s at least in line with market averages and, under a few more optimistic scenarios, I could easily earn a mid-teens return on the stock over five years.

That’s not to say that if a recession pops up in the next six months, the stock won’t sell for cheaper, but all things considered, I feel it’s an exciting first company to use as the foundation for our Intrinsic Value Portfolio.

With that, Ulta will be the first stock added to the portfolio, with a 5% weighting, leaving 95%(!) of the portfolio in cash to be still allocated, which I plan to do over the coming weeks, presenting and analyzing different companies before you here and on The Intrinsic Value Podcast.

You can listen to my full podcast on Ulta here, and let me know in the poll at the bottom of this newsletter whether you agree with my decision.

The Pitch was written a couple of weeks ago, since then, Ulta kept correcting, making the opportunity more compelling.

If you want to upgrade the assumptions, just download the Valuation Model and do so!

That’s it for today! Soon, I’ll also write updates on the recent earnings and company developments (Alibaba, Dino Polska, etc.). Perhaps they will already be uploaded to Circle!

Have a great Sunday!

Daniel

Last Chance!

Flow Traders

An Overview of the numbers:

• Total income: €159 million (+114% YoY vs. Q4 2023)

• Net profit: €63.2 million vs. €6.4 million in Q4 2023 (+888% YoY)

• Fully diluted EPS: €1.42 vs. €0.14 in Q4 2023

• EBITDA: €82.1 million vs. €11.8 million in Q4 2023

• EBITDA Margin: 52% vs. 16% in Q4 2023

• Net Trading income: €153.8 million, of which €72.7 million came from other income

Yes… the YoY comparison was relatively easy to beat, but this was still FLOW’s second-best fiscal year result ever, only outperformed by the 2020 COVID outlier.

In my last EPS estimate, I took a very conservative approach, assuming a result of just €0.35—essentially the same as last year. Instead, we saw an 888% increase 😉. Of course, I knew the US election could trigger volatility, so €0.35 was likely far too low. However, many believed the FLOW thesis was broken, and I wanted to highlight how attractively FLOW was valued, even under low earnings assumptions.

Now, they’ve delivered a fully diluted EPS of €3.56, instead of the €2.58 I had estimated—a phenomenal result (funny enough, the US election didn’t play a big part at all).

Market Context & Volatility Impact

Here’s a comparison between the VIX chart from my last quarterly update and today’s.

As you can see, there was another significant spike in December, triggered by the central bank announcing that interest rates would likely be lowered just twice in 2025.

To me, this event beautifully highlighted the asymmetry FLOW offers. Valued at a P/E of just 8 (based on the previous low estimates), the downside risk was very limited, while any spike in volatility had the potential to generate a quarter like this.

However, as we’ll see in the details, US factors weren’t as relevant for FLOW, which I actually view as a positive.

With that, let’s look at the details:

Regional Performance

Looking at the numbers, FLOW’s market share still appears to be declining based on ETP value traded. However, this is a result of FLOW strategically reallocating its trading capital to maximize returns. Since their capital is limited, they must shift it to where the best opportunities arise, which may temporarily affect market share.

As long as returns validate this approach, I see no issue with it. While growing trading capital is the long-term goal, optimizing its use should be the priority.

Asia:

FLOW achieved its best-ever result in Asia, which isn’t too surprising given its relatively short time in the region. Still, growth rates are highly promising, reflecting the opportunities created by recent stimulus measures we’ve covered in past articles.

Americas:

The US market wasn’t a primary focus this quarter. As I mentioned earlier, there were brief periods of heightened volatility, such as around the election, but after Trump won, volatility quickly declined.

Europe:

Still FLOW’s largest market. Interestingly, Europe also accounted for most of FLOW’s digital asset trading, as can be seen later.

Fixed Income & Crypto Market Dynamics

• Fixed income: No major changes.

  • US investment-grade and high-yield bond volumes increased YoY but declined QoQ.

• Crypto market: Continued strong growth in both trading volume and ETP value traded.

  • Trading volume doubled QoQ and tripled YoY.

  • Global ETP value traded doubled QoQ and increased tenfold (!) YoY.

However, volatility in crypto markets has remained relatively low. Historically, a market crash tends to offer a better opportunity for FLOW than simply higher trading volumes with low volatility.

That said, 2024 marks the first year where the FICC segment has overtaken the Equity segment.

Margins & Cost Management

EBITDA margins have continued to recover in recent quarters, thanks to high operating leverage. Fixed operating expenses grew by just 3% YoY.

However, management provided 2025 guidance for €190-210 million in fixed operating expenses, citing technology investments and strategic hires. If expenses reach the upper range, this could impact short-term results.

Since it's unclear how quickly these investments will translate into financial benefits, I’ll be monitoring this closely.

Trading Capital Expansion Plan

In Q2, Flow canceled the dividend and took a $25 million loan to focus more on capital expansion and take advantage of the high returns on trading capital. The market didn’t like it at all. I thought it was a good idea.

Since then, the stock is up 80%—so I think the market likes the idea now, too (sounds like I always know everything… trust me, I rarely do😅).

Through this measure, FLOW’s trading capital has now reached an all-time high of €768 million.

Be aware: Due to the rapid growth in trading capital, FLOW has changed how it calculates return on capital. Instead of total capital, they now use return on average trading capital based on the last two years.

Earnings Call – Key Q&A Insights

• Further expansion of trading capital (also through debt)?

  • Yes, as long as attractive returns can be achieved. FLOW achieved 69% returns on trading capital in Q4, and with €200 million additional capital, the case for further expansion is strong.

• Threat of losing market share to larger players (Jane Street, etc.)?

  • Market share isn’t the priority. With more capital, FLOW can compete better against bigger players.

Conclusion

Fantastic quarter that reaffirmed the FLOW investment thesis and validated the company's recent decisions. Despite the stock rising 10% today, FLOW now trades even lower (P/E of 7!) due to the strong results.

FLOW is growing, delivering near-70% returns on trading capital, and executing its strategy effectively.

Of course, I stay invested!

I have some additional thoughts on FLOW’s investment case and my future strategy regarding the stock, though.

I’ll discuss that in the Circle Community (for Paid Subs) once it’s live. We’re working on it in the background, and I’ll soon share an update!

For everyone who doesn’t know what I’m talking about:

Next up: Alibaba & Liberty earnings updates—stay tuned!

Until then, have a great day!

Daniel

Alibaba’s stock has climbed 40% over the last four weeks, hitting the same level as in October last year at $113. And it’s up another 4% in pre-market trading, thanks to the Apple news (more on that below).

I’ve been asked a few times recently whether it makes sense to sell now or at least trim the position—especially with the earnings release coming up next week (Thursday, 20th).

As you know, I’ve traded part of my Alibaba position in the $70–$100 range whenever volatility was high. I did the same last October.

But will I do so this time? Honestly, I don’t know yet. Let’s look at the facts and then decide!

Why Did Alibaba Stock Rise?

Earnings aren’t out yet, so the stock hasn’t moved based on fundamentals. So why the rally? Answer: The recent AI Developments and … Speculation.

Last October, the Chinese government announced a stimulus program to boost the economy. Alibaba, along with the rest of the Chinese tech sector, shot up.

The Problem: It had little to do with Alibaba itself, making the rally dependent on the Chinese government. Once the market decided the stimulus announced wasn’t enough, Alibaba’s stock dropped right back down.

What’s Different This Time

This time, the speculation is based on company-based reasons (at least mostly). DeepSeek has revived the Chinese tech universe, and the markets have realized that China is a significant player in AI as well.

Shortly after, Alibaba released its new Qwen 2.5 Max model, which beat both DeepSeek and ChatGPT in most categories.

Alibaba’s Cloud and AI segment has already gained momentum in the last two quarters. With these new developments, hopes are high that Alibaba can gain even more momentum going forward.

On Sunday or Tuesday, I’ll give a detailed rundown on what the Update in March will look like. There’s been a lot of work in the background.

If you’re new and don’t know what I’m talking about, here’s a quick summary:

Then came yesterday’s news: Apple and Alibaba are reportedly partnering on AI features for iPhones in China. Last year, Apple worked with Baidu but wasn’t satisfied with the results. Choosing Alibaba over all competitors, including DeepSeek, strengthens its market-leading AI and Cloud position in China.

In short: This rally is different because it is company-related.

That said, next week’s earnings won’t reflect the impact of this latest news. Previous earnings reports didn’t do much for the stock, and if I had to guess, I’d say there’s a slightly higher chance of a drop than a rise post-earnings.

But it all depends on how management presents their outlook. If the numbers come in weak but they convince investors that recent developments will drive long-term growth, the stock could hold up.

If the numbers are good anyway, the direction of the stock should be clear. I’m just a skeptic by nature, so I prefer to have little anticipation before earnings.

Valuation: Still Ridiculously Cheap

Even after this rally, Alibaba is still significantly undervalued.

Normalized free cash flow (FCF) is over $20 billion per year, even with over $10 billion spent on stock buybacks (as we saw in 2023 and 2024).

Factor in the dividend, and Alibaba would have had $21 billion in FCF. That puts EV/FCF at 11.8x. If you also account for the massive $16 billion (!) in buybacks in 2024, that drops to 6.7x—equivalent to a 15% FCF yield.

But I don’t need to tell you that—you already know all this.

Decision: Sell or Hold?

Even after a 40% rally, Alibaba’s long-term potential is still massive. But obviously, the risk/reward shifts after such a big move.

If you’re sitting on a large Alibaba position and have other stocks that look attractive, it might make sense to trim, maybe even before earnings.

Even if there’s a 50/50 chance of a 10% increase or decrease, the risk/reward looked much better at $80.

Personally, I’m not selling or trading. My cash position is still over 30%, and I have no immediate alternative that’s better than holding Alibaba long term.

Also, I’ve never traded going into earnings or anything. I sold when prices reached +$95, which has been only once or twice and bought back at $80 or below. Calling this trading might be a bit too much.

I’ve waited long for Alibaba to gain some momentum, so I’m enjoying the ride while it lasts. 😉

What’s Next?

Tomorrow: Flow Traders reports earnings, which should be interesting given the recent uptick in volatility. I’ll keep you posted.

Sunday or Tuesday (not sure yet): Q&A about the Upcoming Update in March. I’ll give you a detailed rundown of how it will look! (Any questions? Let me know!)

Thursday 20th: Alibaba Earnings Update

Don't Miss out on Those!

Till then—cheers!

Daniel

As investors, we need to form our own opinion on these questions. I’ll try to give you all of the information you need to do that today.

We will discuss the iGaming industry, analyze Evolution’s Business and Moat, assess the Risks, and, in the end, I’ll give you my Valuation and Investment Decision.

Starting in March, you can get even more extensive Deep Dives every Week + Many Additional Features. Learn more about them here:

Become a Member now at the best price ever: $16/Month instead of $100/Month

Save the Offer

Content

• Introduction to Evolution

• The iGaming Industry

  • Evolution Products

  • Market Size and Outlook

    • Online (+ Offline) Gambling

    • Regulation: Overview and Discussion

      • Regulation by Region

      • Legalization or Ban

• Evolution Financials

  • Income Statement

    • Georgia Strike, Cyber Attacks, Expansion

  • Balance Sheet

    • Capital Allocation

  • Cash Flow Statement

• Competition and Competitive Advantages

• The Investment Case/Decision

  • Valuation

    ---

🃏 Introduction to Evolution 🃏

Evolution is a Swedish creator and provider of Live Casino Games. EVO was founded in 2006 and is headquartered in Stockholm. It’s the undisputed market leader with a 60% market share and has grown tremendously over recent years, which fueled the stock price.

However, 2024 was not a great year for the company and even worse for the stock. Growth slowed down compared to recent years; strikes in one of EVO’s most important studios raised concerns about the work environment and impacted operations, and cyber attacks in Asia caused zero growth in the region QoQ.

But how big are these problems in the long term, and is the price now cheap enough to compensate for that? After all, great opportunities are created by temporary headwinds.

Overview of Evolution’s Numbers:

• Market Cap: $15.95 Billion

• Enterprise Value: $15.2 Billion

• Shares Outstanding: 206,56 MM

• NTM P/E: 12,72x

• EV/FCF: 12.3x → FCF Yield: +8%

Today’s goal is to provide you with the information you need to assess the investment case of Evolution. Therefore, we’ll analyze the industry itself as well as the company.

Let’s start with the industry and slowly go into EVO’s position in that market.

🎰 The iGaming Industry 🎰

In a world where everything is moving online, it shouldn’t come as a surprise that one of the oldest forms of entertainment—gambling—has made its way into the digital world. What once required a walk into a brick-and-mortar casino is now available 24/7 online.

To prevent misunderstandings going forward, let’s quickly clarify the terms “iGaming” and “Online Gambling”.

Online Gambling: Narrower term that includes “traditional” forms of gambling like: online slots, roulette, blackjack, as well as sports betting. Online Gambling is a subset of iGaming that (mostly) excludes skill-based games.

iGaming: Broader term that includes all forms of Online Gambling but adds all other forms of online betting or wagering money. Think of Fantasy Football, esports betting, or video games with gambling aspects (CS:GO, FIFA, Overwatch, etc.)

In addition to the traditional games, live dealer games are growing in popularity. These games feature actual human dealers running games in real time using streaming technology. This is what EVO specializes in.

Stop Gambling in Stocks ;)

The games are a more immersive, interactive experience, combining the convenience of online play with the authenticity of a physical casino. However, the real specialty and innovation in the space that EVO brought are large-scale game shows. These games can host tens of thousands of people at the same time.

Here’s an example of EVO’s most famous game and the most popular game show in the world - Crazy Times:

Crazy Time is based on a large spinning wheel divided into numbers (1, 2, 5, 10) and four bonus segments. Players bet on which number or bonus round the wheel will land on. If it lands on a bonus round, players enter that round, which offers the chance for larger multipliers.

The bonus rounds are:

• Coin Flip: A virtual coin is flipped with a multiplier on each side.

• Cash Hunt: Players pick a symbol that reveals a multiplier.

• Pachinko: A ball is dropped into a board with pegs, landing in a pocket with a multiplier.

• Crazy Time: A bonus wheel with high multipliers is spun for a chance at big payouts.

Who Buys Evolutions Products (Games)?

While EVO interacts directly with the players, they are only indirectly its customers. EVO sells its games to so-called Operators.

These Operators are the actual casinos that players are logged into. There are three types of Operators:

1. Brick-and-Mortar Casino: Classic brick-and-mortar casinos have realized that gambling has entered the digital world, so they are also expanding into this space. Evolution has just agreed to build a new studio in Pennsylvania in a deal with the US casino giant Caesars.

2. Online Casino: Online casinos are native to the digital space. Some of the biggest online casinos include Bet365 (England), 888 Holdings (Gibraltar), Flutter (Ireland), and MGM (USA). These casinos build EVO's main customer base. EVO sells its games to them and takes commissions on their winnings.

3. Game Aggregator: Game aggregators are platforms that compile a variety of games from different game developers and provide them to online casinos or gaming operators in a single, unified solution. Examples include: Relax Gaming, SoftSwiss, and EveryMatrix.

The commission EVO earns is calculated as a percentage of the operators’ winnings generated via the company’s casino offering. On average, it’s between 10-12%.

Advantages of being B2B (EVO) instead of B2C (Operators)

Online gambling is not an easy business to be in. Regulations can be demanding, and players must trust the sites immensely to place their funds on the websites.

The fact that EVO sells its games to operators (B2B) instead of dealing directly with the players (B2C) makes their life a lot easier. There are three main difficulties for B2C operators:

1. Identification: Casinos must ensure that their customers are of legal age. Thus, they need processes to verify IDs. This is not necessarily easy, and it’s risky. If there’s a way to trick the system and casinos have underaged people play, it can end the business.

2. Payment Processing: Casinos must be trustworthy, and the payment process must be flawless to guarantee that there will be no problems placing bets or withdrawing funds.

3. Marketing: The online casino space is incredibly competitive. To secure customers, casinos pay huge amounts in marketing expenses. If you’re a sports enthusiast like me, I’d bet a good amount of money that you’ve seen gambling site sponsors before.

EVO doesn’t care which casinos come out on top; they sell their games to whatever casino can successfully solve the challenges above. That also means that EVO doesn’t share any risks or costs involved in solving those problems.

Market Size and Growth Outlook

In 2023, Global Online Gambling revenues stood at €107.6 Billion (Source: H2GC). Most Research houses expect a CAGR of 7% to 12% until 2030. The significant differences in the growth estimates arise from varying assumptions on regulations, technological advancements, and the growth outlook of the many different segments. EVO operates in the Live Casino and RNG segments. Live Casino revenue grew at a rate of 23.9% annually from 2019 to 2023, and RNG revenue grew by 20.8%. 

Europe is the biggest market by region (UK, Germany, and France at the top), with Asia catching up quickly in recent years. The US is also growing faster due to more legalization. Legalization is a keyword here. The black market for Online Gambling is huge. All the numbers mentioned only account for legal online gambling.

Adding Land-Based Casinos

Intuitively, I would’ve thought Online Gambling would have long surpassed land-based gaming by revenues. Or at least grow to a similar size. This couldn’t be further from the truth.

According to estimates from H2GC, land-based casinos still represented 75% of the total gaming market in 2023. Based on their estimates of a total gambling market (offline + online) of ~€490 billion, that leaves over €380 billion up for grabs for Online Gambling to take.

Of course, land-based gambling will not disappear, but comparing the growth rates suggests that Online Gambling will take significant market share, especially with live casinos delivering basically all the advantages of land-based casinos with a lot more convenience. Since the land-based casinos are piling into the space themselves, they’re not competitors anyway. They’re potential clients.

Regulation: Risks and Chances

One of the major concerns surrounding EVO is the regulatory environment. Here’s an overview of the current regulations by region.

Overview of Regulation by Region

The following overview of regulations is organized by the revenues EVO generates in each region, starting with the most important region and proceeding to the least important.

#1 Asia: (Revenue Market Share in 2024: 39%)

Asia is mostly unregulated and hosts one of the largest black markets in the world. However, the Philippines recently became the first country in Asia to legalize Online Gambling, and WinZir, a Philippine Online Gambling platform using EVO’s games, is the first licensed one.

EVO will also build a studio in the Philippines. Building one was part of the agreement to get a license, but beyond that, I expect the country to be a great place to expand. Labor is cheap compared to other countries with studios, and English efficiency is the highest in Asia (next to Singapore). Besides that, there is a huge population for the business to expand.

#2 Europe: (Revenue Market Share in 2024: 38%)

The European Union (EU) does not have a unified Online Gambling regulation; each member state establishes its own laws.

• UK: The Gambling Act 2005 is the main regulation in the UK, defining gambling terms and setting license requirements.

  • Special Development for EVO: The UK Gambling Commission has launched a review of Evolution’s operating license in the UK after finding EVO games provided to unlicensed casinos.

    • EVO took the games down and fully cooperated with regulators. Further details are still unknown. For perspective, the UK accounts for 3% of EVO revenues.

      

• Germany: The Interstate Treaty on Gambling 2021 regulates online gambling, regulating online casinos and poker rooms under strict conditions and harmonizing regulation across all states.

  The regulation includes a ban on certain games, Deposit Limits, an Advertising Ban, and Mandatory ID checks.

  It’s especially tough on operators and one of the negative examples of regulation.

• France: The French Online Gaming Regulatory Authority (ARJEL) oversees the market and regulates online gambling. France is the most heavily regulated country in Europe, and its tough regulations have created the biggest black market in the continent. (Maybe that sounds paradoxical to you, but we’ll get to that.)

  ---

#3 North America: (Revenue Market Share in 2024: 12.5%)

• United States: Online Gambling laws are determined at the state level, leading to a fragmented landscape. Sports betting is widely legalized, while online casinos are only legalized in a few states.

These are the US states where Online Gambling is legalized, and EVO holds all possible licenses: Connecticut (1 Studio), Michigan (1 Studio), New Jersey (2 Studios), Oklahoma, Pennsylvania (1 Studio), and West Virginia.

EVO is also expanding in the US, building out its headcount, offering new games, and partnering with local casinos.

• Canada: Similar approach, with provinces like Ontario regulating Online Gambling while others have less formalized frameworks

EVO operates 2 Studios in British Columbia.

#4 LatAm: (Revenue Market Share in 2024: 7%)

Once again, many different laws depending on the country. An important market for EVO’s future will be Brazil. Brazil recently changed local laws around Obline Gambling regulation, and EVO will build a studio in Brazil in 2025. Columbia will also be part of an expansion:

#5 Other: (Revenue Market Share in 2024: 3.5%)

The Overall Trend: Legalization or Ban?

First of all, let’s discuss terms again since the difference between legal and illegal gambling is not as obvious at first. Sure, one is legal, and one is not… but what are the implications of that on a state and consumer level?

In short, legal gambling is licensed, and illegal gambling is not licensed. There’s not necessarily anything inherently criminal about black market operators besides gambling without a license (at first), which is why consumers often don’t even know if they gamble on legal or illegal sites.

Ismael Vali, CEO of the intelligence platform Yield Sec, recently held an interesting talk on the iGB@ICE and discussed the implications and consequences of regulation on gambling markets.

His main thesis: Current Regulation benefits Black Market Gambling

The reasoning is simple: Demand is high, and the barriers to start playing are low. This leaves two options on the table:

Option 1: Legalize Gambling → Generating Tax Revenues, New Jobs, Responsible and Safe Use

Option 2: Criminalize/Bad Regulations → Eliminate the Licensed Players → Drive Demand to Black Market Sites → No Tax Income, No Jobs, Scams, Crime build on top of Gambling Organizations

Because of this, he advocates regulation that leaves room for operators and strongly advises against banning online gambling or putting regulation in place that is a de facto ban.

Globally, this seems to be understood. There’s a trend towards more legalization.

Financials: Risks and Chances

There’s no better thing than going through a company’s financial statements and asking the right questions when you want to understand a company. So that’s what we’re going to do.

Income Statement

As mentioned, EVO earns money through commissions paid by the operators for using EVO’s games/streams. There are fixed and variable fees.

For live casino, the most basic agreements normally include access to, and streaming from generic tables, while more complex agreements can include dedicated tables and environments, VIP services, native-speaking dealers and other customisations to produce a live casino experience that is unique for the end user and helps the operator to stand out from the crowd.

Fixed fees are for the dedicated tables that are branded for the specific operator. Variable fees are revenue splits between EVO and the operator. They’re paid monthly and vary depending on the games EVO provides, the number of tables, and the active hours. On average, they are between 10-12%, although they can vary widely.

EVO’s long-term development looks like the dream of every investor.

Revenue Growth: 3Y CAGR of 25% and 5Y CAGR of 41%

Net Income Growth: 3Y CAGR of 27% and 5Y CAGR of 53%

FCF Growth: 3Y CAGR of 30% and 5Y CAGR of 51%

However, growth has slowed in recent quarters. Several factors contributed to this. We will discuss each in detail. Before we get to that, you might ask why I say growth has slowed when total revenues grew 31.5%.

That’s because we focus on Net revenues and ignore the “Other operating revenues.” These include reductions in earn-out liabilities from an acquisition in 2022. Since they’re non-cash income, they’re also adjusted for in EVO Adj. EBITDA numbers and FCF. It’s “artificial growth” with no substance for EVO’s business performance.

Reasons for Slowing Growth

1. Currency Headwinds and Tax Rate

Over the entire year, EVO had faced currency headwinds that decreased revenues by 3-4% depending on the quarter. In Q4, revenue growth on a constant currency basis was 16% instead of 12%. There's not much you can do about that. In some years, it’s a headwind; in others, it’s a tailwind.

EVO also experienced an increased tax rate due to the US expansion and Pillar 2 legislation in Sweden. In 2023 and prior, EVO’s effective tax rate amounted to 6-7%. Pillar 2 requires EVO to pay an additional tax when their effective tax rate is lower than the minimum tax rate of 15% in Sweden.

2. Strike in Georgia

Georgia has become EVO’s most important studio in recent years. I’ve read estimates that about 45%-55% of EVO’s profits were generated in that studio. In mid-July of 2024, however, about 500 workers left their jobs and started protesting for higher wages and better working conditions.

It’s difficult to assess the situation if you’re not on the ground. Strikers report a toxic work environment and poor workplace conditions. On the other hand, EVO showcases pictures of attractive studios with gyms and various amenities. However, they did admit to mistakes regarding hygiene issues and inappropriate behavior by some middle managers in certain studios.

Those things should be quick to fix, though, especially since EVO’s management seems to take these problems seriously. The bigger problem was wages. From what I know, the wages EVO pays in Georgia (14,000-25,000 GEL, according to Glassdoor) seem competitive and not below what is expected for this job.

However this turns out, I wouldn’t consider this a long-term problem, and I expect EVO to 1) improve on their operations and work environment and 2) diversify operations better (which could be done through the Philippine studio, for example)

3. Cyber Attacks in Asia

Over the last three years, Asia has been Evolution's main driver of organic growth. Then, in Q2, growth slowed drastically, reaching only 3.1%, down over 7% YoY. However, management explained the slowdown with cyclical market behavior, which seemed realistic since the quarter before showed lots of growth at 15.9%. However, growth rates for Q3 halved again and went to 1.5%.

The CEO then addressed issues with Cyberattacks:

The problem has not been solved yet. In Q4, growth rates were flat. If this issue is not resolved, it will have a longer-term impact on EVO’s business, so it’s worth monitoring any developments there.

4. Unregulated Markets

EVO still generates 60% of its revenues in unregulated (grey and black) markets, which has multiple implications. 1) there’s the risk of legal action against EVO. 2) margins are likely higher in unregulated markets. So, if the market gets legalized, margins could come under some pressure.

It also offers potential upsides, though: Cyber attacks like the ones in Asia are less likely in regulated markets. Thus, regulating markets increases stability for EVO’s business (important for investors as well). As one of the most credible game providers, they also tend to be among the first to get licensed as soon as markets become legal.

Revenues by Game Type

Looking at revenues by game type, we can see that Live Casino is clearly the dominant part of revenues. The RNG segment became a part of EVO after acquiring NetEnt in 2020 in a $2.1 Billion deal. After slow to no growth in the first years, the RNG segment grew 6.7% YoY, and management is positive that growth will continue going forward.

Revenues by Customer

EVO has a very concentrated customer base. 46% of its earnings come from the five biggest customers and 13% from the biggest one alone. On the one hand, this is a risk. If one of them, for whatever reason, goes out of business or leaves EVO, it will have a severe impact.

However, it also shows us that EVO seems to be inevitable in the Live Gaming space. EVO raises commission fees annually, has profit margins in the mid-50s to low-60s, and customers still stay.

Margins

We can make this quick since we already discussed the impact EVO experienced on margins in 2024. Overall, EVO’s margins are still looking great. As soon as the problems in Georiga and Asia are solved and the US expansion benefits from EVO’s typical scale, I think there’s a chance for improvement again. Even if not, holding this level of margins would be great for a company of EVO’s size.

Keep in mind that the margins in the chart include Other operating income (reduced earn-out liabilities). Thus, adjusted margins are a bit lower:

Balance Sheet

The balance sheet ticks all the boxes: €800M in cash on a €15 billion market cap, no long-term debt, and no indications of any red flags. So, the question is:

What is EVO doing with its cash?

Capital Allocation:

EVO traditionally has a dividend policy that requires it to distribute 50% of net profit annually. Accordingly, EVO announced a €2.80/share Dividend, which resembles a dividend yield of 3.8%.

However, they also bought back shares when the stock price had become attractive in recent years. The chart below beautifully shows how they repurchase stock whenever prices decline.

To respond to the 35% stock decline in the last LTM, EVO announced a €500M buyback program. Based on the current market cap, this could buy back 3.3% of outstanding shares.

In my opinion, when the stock price is at 3-year lows despite a still strong fundamental business, more buybacks would be a better option than keeping the dividend policy going. However, it doesn’t sound like more buybacks are planned in 2025, even if the stock goes down further.

The phrase “during 2025" gives me the impression that they’re closing the door on further buybacks later in the year.

Competition and Competitive Advantages

When considering Evolution’s margins and customer concentration, one question should arise: Is there no competition?

Rather than providing another lengthy block of text and extending this article, the website LiveCasinos offers excellent summaries and overviews of all the companies in the industry.

Short Overview:

EVO’s main competitors include Playtech, VIVO Gaming, and Pragmatic Play. Only Playtech and Pragmatic focus as much on the Live Segment and Game Shows as EVO does.

Playtech's revenue level is similar to EVO's, reaching $1.8 billion last year. However, their margins are significantly lower. The lower margins stem from a wider product mix, including lower-margin products, less targeted markets, and, most importantly, less scale.

They have an estimated 15% market share in live casinos, compared to EVO’s 60%. This is partly because they operate almost exclusively (~90%) in regulated markets.

I want to focus on EVO’s competitive advantages since the numbers clearly show that these competitors are not a viable alternative to EVO’s customers. Otherwise, margins and customer retention wouldn’t be this good.

EVO’s moat is based on many factors, but they all boil down to one thing - Scale.

The advantages of scale include:

1. Distributing Costs 💰

EVO can invest significantly more in its games since the costs are amortized more quickly due to its large player base. Better games, on the other hand, bring more revenues, higher margins, and, ultimately, more profits.

The same goes for investments in infrastructure. Online gambling is a sensitive business. You can’t allow mistakes with customers’ funds at stake.

2. Regulatory Advanatages 👩🏽‍⚖️

As mentioned, when countries legalize online gambling, EVO will be one of the first players in that region. This will give them a headstart in customer acquisition, acquiring the best employees, and becoming the best-known and most trusted brand.

3. The Mathematics of running an iGaming Business 🧮

Considering the size of the land-based casino market, I used to wonder why these casinos do not create their own live streams.

Then I saw a simple calculation on Twitter, and it was the first time I really thought, “Ahh, that’s why this business works.”

Instead of rewriting a worse example, here it is:

Once again, the main differentiator is scale. A quick anecdote if the above doesn’t convince you. In Europe, the still biggest online gambling market in the world, there hasn’t been a single casino trying to get into the market of life streaming their games. No one knows their business better than they do; they clearly think it’s not worth it or not possible.

Investment Thesis

Read more

Anyway, good for me, I decided to add to my position if the earnings call, which is in the next hour, won‘t have any surprises.

Quick Note: Since Evolution ($EVO) is releasing earnings today, I decided to send the Evolution Deep Dive next week so it‘s 100% up to date.

I invested on the premise that we have one of the few very well-managed companies in this beaten-down sector.

This quarter showed that High Tide is in fact that company.

Here’s an overview of the reported numbers:

Revenue of $138,3M vs. Est. $135M → Beat ✅

Adj. EBITDA of $8,2M vs. Est. $7.6M → Beat ✅

GAAP EPS of $-0.06 vs. Est. $0.00 → Miss ❌ (EPS is masked by Depreciation and Amortization)

2024 FCF of $22M vs. Est. $20.5M → Beat ✅

ELITE Members up 171% YoY → Tremendous growth! ✅

*All numbers in CAD

Now, let’s dive into the earnings report in more detail.

In case you haven’t read my initial stock pitch, it might make sense to do that first:

Store Count

High Tide increased its store count by 29 to a total of 186. It aims for annual store count growth of 20-30, so it reached the high end of its guidance this year. The ultimate goal is to have around 300 stores in Canada.

As long as the same-store sales grow (+5%) and the company generates cash flows (spoiler: they did), store count growth is a reasonable goal. Evidence for its strong brick-and-mortar performance is shown in the fact that HITI only owns 5% of all cannabis stores in Canada but holds a market share of 11%.

Membership Program

One of HITI’s biggest successes has been its loyalty program, released in 2022. It has 5.3M members globally and 1.7M in Canada alone. Even more important is its paid ELITE subscription, which followed in Q4 of 2024 and surpassed 76.000 members.

The growth of HITI’s ELITE Member Program:

6,000 Members in Q4 2022 → 28,000 Members in Q4 2023 → 76,000 Members in Q4 2024.

Growth Rate from 2022-2023: 366% Growth Rate from 2023 to 2024: 171%

In Q4, growth even accelerated compared to prior quarters as can be seen in this little visualization of the growth:

Geographical Breakdown

After Trump got elected, all cannabis stocks dipped. My thesis was that HITI wouldn‘t be hit by changing laws even if they would come.

I turned out right (every dog has his day), and HITI rallied after that dip. The table below shows why US regulation would have little effect on HITI.

The US and international business (both exist only as e-commerce) have been significantly reduced in recent years (see original article).

Revenues for the Canadian operations grew 12% YoY, while the US and international revenues declined 32% and 40%, respectively. Competitive pressures in the CBD sector caused the decline. While you never like to see declining revenues, I wouldn’t interpret too much into this since High Tide’s primary and successful business model is Canada’s brick-and-mortar business.

Additionally, the downsizing of loss-making operations is what made High Tide the cash-flowing business it is now. It was a strategic decision to move away from e-commerce—a good decision by the management, especially considering the growth in e-commerce during the pandemic and the high gross margins that could easily fool someone into thinking that the trend continues. It is not easy to step away from that business when it deteriorates.

Many would hold on and try to save the loss-making business.

Overall Revenue grew 12% YoY, driven by the store count expansion and 5% same-store sales. It’s safe to say that after the focus have been on profitability and cash flows, revenue growth also returns. Accessories and the Data analytics business were growing quickly as well, and data analytics could soon become a more significant contributor to total revenue.

You may wonder what the Data analytics business is. It’s called Cabanalytics Business Data and Insights Platform, and it's a subscription service offering a monthly report of anonymized consumer purchase data (dispensaries, consumer behavior, sales trends, product performance, etc) that can be used to optimize operations and marketing strategies.

Its revenues grew from $12.2M in 2021 to $36.7M in 2024. Unfortunately, we don’t know the margins (HITI doesn’t report margins of individual segments).

I would like to see a more detailed breakdown of the segments in the future. How much revenue comes from the data business, and how much from advertising? Based on the growth rates, advertising is unlikely to play a big role.

The one international market HITI wants to focus on more is Germany. More on that later. Let’s discuss the most important part now - High Tide’s cash flows…

Free Cash Flow

Q4 of 2024 marks the 6th consecutive quarter of FCF. Cash grew by almost $20M as a result of that. Overall FCF of 2024 was almost $21,991M compared to $6,940M in 2023 - an increase of 217%.

In case you wonder why the EBITDA margins decreased throughout the year, this was due to a decrease in the e-commerce EBITDA margins. EBITDA margins for the core business remained stable at 8%.

Understanding High Tide’s EPS

Read more

DeepSeek unveiled a free, open-source AI assistant that uses lower-cost chips and less data than its American counterparts. For comparison, DeepSeek spent $5 million, yes million, not billion, on training their AI model.

OpenAI, the company behind ChatGPT, recently raised $6.6 billion and borrowed an additional $4 billion to develop its model. $10 billion vs. $5 million…

Google, Microsoft, Amazon, and Meta spent a combined $300 billion on AI research in 2024—a number that is expected to grow significantly in 2025 and the years ahead.

If you look at the performance results between DeepSeek and OpenAI models, it’s not surprising that the huge investments of Big Tech are now being questioned:

DeepSeek performed on par or better in every category of the test. While I was initially a bit cautious about the numbers DeepSeek reported, dozens of industry experts, even competitors, supported these numbers.

There’s still a question about the costs. Maybe DeepSeek understated the actual costs to make it seem even more impressive. However, it’s widely accepted by now that it operates at only 3% to 5% of the costs of OpenAI’s model, and the difference is so huge that a couple of million more or less does not make a difference.

Why is DeepSeek so much cheaper?

In short, because the US sanctioned chip exports to China. Precisely, Nvidia’s H100 chips were not allowed to be sold to China. Thus, DeepSeek was trained on the weaker H800 chips. Apparently, the difference is not as big as experts in the industry thought.

Consequently, it is no surprise that Nvidia stock is down significantly on this news (-12% pre-market).

It does not look much better for the overall tech industry:

Within just six months, China’s AI companies caught up to their American counterparts, even without access to the same chips. Initially, US experts thought America was years ahead. Former Google CEO Eric Schmidt said that:

In the case of artificial intelligence, we are well ahead, two or three years probably of China, which in my world is an eternity.

Recently, he said that China has caught up much faster than expected and that there is an open race between the US and China.

So, back to the original question. What does this teach us about Moats in highly innovative industries?

1. Leaders get Replaced quickly

The more innovative an industry is, the more likely it is that the current market leader will be replaced sooner rather than later. Just a couple of weeks ago, it looked like Nvidia chips would be the standard for decades to come.

Now, it’s questionable if you really need Nvidia chips to train AI models when even the old Nvidia chips can do it. Certainly, other companies can make chips with the same quality as “outdated” Nvidia chips.

→ We don’t know how this will play out. Fact is, you pay 36x forward earnings for a company whose growth outlook became much more uncertain within just 5 days, and no one, not even the experts, saw it coming.

I’m not saying Nvidia will be a bad investment going forward, but who can really say Nvidia or AI companies are in his circle of competence when not a single expert saw the developments of just the last 8 weeks coming…

2. High Risk Investments

The American tech giants invest hundreds of billions in AI technology. If other companies can do it without spending a single billion, we have to question the return of these investments…

→ Everyone wants to be the first mover to introduce new innovations. This leads to drastic overspending and burning their (and their investor’s) money.

3. How much Money will be generated in the End?

The more high-quality AI models there are, the more they become a commodity. Pricing power diminishes drastically. When ChatGPT was without an alternative, OpenAI could set the prices. Now, many models are at about the same level, and there will only be more from here on out.

How profitable will the business be when it’s out of its growth state?

→ Many industries have changed our lives (think of airlines), but the companies operating in those industries have been bad investments. Who knows how it’ll be for AI?

Bottom Line:

I’m not saying there is no money to make investing in AI. I’m pointing out, though, that there’s always a price too high (shoutouts to Howard Marks). DeepSeek is a beautiful example of how fast alleged moats can be disrupted.

How will all of this turn out? I don’t know yet. I’m happy, though, for the volatility in the markets (hopefully, Flow Traders can do some good business 😉)

I also want to do some more research regarding this development and the immense price reductions Alibaba and its competitors have recently made for their cloud and AI services. Maybe there have been cost advantages already that led to them initiating these price reductions.

Well, that’s it for today’s short article; let’s call it a market update. I hope you enjoyed it!

On Friday, a new Deep Dive is covering my latest Portfolio addition. Paid Subscribers know what company I’m talking about.

Till then, have a great time and think about the Risk/Reward ratios of your investments 😉.

Best

Daniel

All information about the Big Update coming in March:

These posts will sometimes be briefer than my usual ones just because the businesses are typically well-known (which is totally fine!). So, instead of explaining the business and industry in detail, I will give a shorter introduction and then follow with my opinion on the current investment case.

My next Stock pitch (scheduled for next Friday for now) will be more extensive and deal with the company I added just yesterday to my portfolio (Paid Subscribers got a notification).

After many small-cap investments, this is my first large-cap investment in a while. In 2025, there will be a greater mix of small and large-cap investments.

Don’t miss it and become a Founding Member!

Learn more about what changes in 2025 and secure the lowest price ever:

Become a Founding Member

Content

1. Introducing The Gap

2. The Gap Stock

   1. Past Performance and Current Valuation

3. Recent Results and Turnaround Story

   1. Income Statement

   2. Balance Sheet

   3. Cash Flow Statement

4. Competition

   1. Lululemon

   2. H&M

   3. Abercrombie and Fitch

5. Brand Breakdown

   1. Athleta

   2. Old Navy

   3. Gap Global

   4. Banana Republic

6. Geographic Breakdown

7. Investment Case

   ---

Introducing The Gap

GAP is a leading American clothing and accessories retailer founded in 1969 in San Francisco. It operates four brands: GAP, Old Navy, Banana Republic, and Athleta. Here’s an overview of what the brands stand for:

We will look at each brand's recent results individually, but first, let’s take a look at GAP’s stock development.

GAP Stock

GAP stock has been extremely volatile since… well, ever.

If we look at the 10-year returns, GAP has delivered a negative return of around 40%. If we take a 5-year period, GAP is up ~40%, and in the past twelve months, GAP is up 31%. And even in those 12 months, GAP has traded from a low of $18.6 to a high of $30.6. As I said, the stock is volatile.

The stock looks cheap on a fundamental basis. The forward P/E stands at 11x, just like the EV/EBIT. Compared to its competitors, GAP is one of the cheapest companies in the industry. However, AEO (American Eagle) and ANF (Abercrombie and Fitch) are equally cheap, especially in the second comparison. This could suggest that “cheap” is the wrong word and that these multiples are fair for apparel companies in the current environment.

Sure, Nike and Lululemon are trading at higher multiples, but the businesses are superior in many ways. Nike currently struggles on a fundamental level but has the strongest brand of all companies. Lululemon has arguably the second-strongest brand and, as we will see in a minute, still grows decently (outside of the US).

Nevertheless, what makes GAP seem attractive is the turnaround that happened since Richard Dickson joined as the new CEO. If this turnaround is real and improves GAP in the long run, it might deserve higher multiples going forward. Combined with earnings growth, that could be a good opportunity.

Let’s check out the turnaround story:

Recent Results and Turnaround Story

GAP’s business performance has not been great over the last decade. Revenues and net income are lower than they were 10 years ago. Even in recent years, revenues kept declining. However, profitability has increased significantly in 2024.

Income Statement Turnaround:

All four brands have returned to growth (more on that later) after delivering lousy results in 2022 and 2023. The declining revenues hide the fact that operating margins have improved significantly since Dickson took over, leading to remarkable growth rates for operating and net income.

Balance Sheet Turnaround:

When I research a company, the first thing I check is its balance sheet. I’d only invest in companies with a weak balance sheet on rare occasions (special situation investments). GAP’s balance sheet can be considered healthy. Since Dickson came in, the company has focused on growing its cash position (64% growth YoY), which I like, especially in a weak market environment.

In absolute terms, the cash position increased by over $600m and now exceeds long-term debt. Merchandise management has also improved significantly. Ending inventory in Q3 decreased by 2% year over year and was consistently lower throughout 2024 than in 2023, which has been the main driver for the improved merchandise margins (90bps increase year over year). In Q4 of 2023, the first full quarter with Dickson on board, ending inventory decreased by 16% year over year.

There’s a clear path to cutting opex and focusing more on profitability, which is a welcome change for investors.

Cash Flow Turnaround:

Cash flows also recovered from the 2022 levels. However, that has already been the case in 2023. Year-to-date net cash from operating activities was $870 million. Year-to-date free cash flow was $540 million.

I may remind you that these strong 2024 numbers are generated in a very challenging industry environment. The apparel industry shrank by 1.5% last quarter due to weak consumers, inflation, and weather events like hurricanes and storms. (GAP disclosed that the weather extremes cost them approximately 1% of net sales growth.) I don’t know yet if the fires impacted the business and, if so, how much.

We recently talked about Nike and their problems. If the industry's biggest and most powerful brand struggles this much, these results are even more promising. Now, you might say the problems at Nike are unique to the company and that it is primarily a shoe retailer that only generates 14.5% of its revenues from apparel. And you’d be right. However, Gap’s more direct competitors also felt the pressure.

Competition

Lululemon:

LULU has been the industry's growth stock in recent years. However, after a challenging year in 2024, the stock more than halved from the beginning of the year to August. As so often, the market overreacted and realized its mistake later that year. In response, the stock rallied 65%. While still below all-time highs, it recovered quite well.

But how do the fundamentals look?

At first glance, LULU grew at decent rates. In Q1 2024, revenues increased by 10%, in Q2 by 7%, and in Q3 by 9%. However, on closer inspection, you will see that LULU also struggled with lower demand. Over 74% of revenues are generated in the US and Canada, and growth in this region is much lower than overall sales growth would suggest, averaging only 2% from Q1 to Q3 of 2024.

So, overall growth was primarily fueled by the 40% average growth in China and 26% average growth in the rest of the world. These are strong growth rates; however, if the US business fails to regain growth in the long term, overall revenue growth is likely to decelerate considerably.

H&M:

H&M is clearly encountering problems in this challenging environment. While it delivered a good second quarter, its overall performance in 2024 was rather weak. It lost market share across all geographies except East Europe.

The operating margin decreased 1.9% year over year in Q3 due to increasing SG&A expenses and forex headwinds. The total number of stores decreased from 4,375 to 4,298.

Abercrombie and Fitch:

Abercrombie and Fitch is one of the few companies in the industry that can report good numbers across the board. Its top and bottom lines grew, and its operating margins are attractive at around 15%.

As is often the case when a company outperforms over a couple of quarters, the market expects this outperformance to last forever. Despite posting earnings in line with expectations, the stock tanked (-18%) after the latest earnings release two weeks ago. The guidance wasn’t the problem either, as it was also raised.

To summarize, while most companies in the industry struggle, companies like Abercrombie and the Gap can consistently gain market share and improve their financials quarter over quarter.

Let’s examine Gap's individual brands to determine where their growth comes from and whether it is likely to continue.

Brand Breakdown

The table below shows the comparable sales by brand. To get a better idea of real sales growth, the comparable sales (or like-for-like sales) adjust for sales from new stores opened and stores closed.

Athleta:

Let’s start with Athleta since we see the most significant turnaround here. Just a year ago, comparable sales declined in every quarter and totaled 12% in the fiscal year. In 2024, the picture changed and Q1 and Q3 showed 5% growth each. In the second quarter, comparable sales declined by 4% because of a previously planned and communicated discounting campaign to reset the brand image.

Judging by the numbers, the rebranding works. However, I lack “on-side insight.” That makes it difficult for me to judge the brand on a quality or popularity level. According to the company, the brand is attracting high-value customers and is building a community (the numbers support this). On TikTok, it became one of the fastest-growing sportswear brands since its launch in February.

Athleta currently generates ~7.5% of GAP’s sales ($290m of $3.8b).

Old Navy Global:

Like Athleta, Old Navy was a problem child for GAP in 2022 and the first half of 2023. Since then, the business has changed its focus and regained strength, growing comparable sales each quarter. In Q3, growth was slowed due to weather-related headwinds, which resulted in store closures. Gap closed 180 stores, of which 90 were Old Navy stores.

This is what the management said about the business changes:

Old Navy is GAP’s most important brand by revenue, generating ~78.5% of GAP’s sales ($2.2b of $3.8b).

Gap Global:

Gap Global has been the most stable brand in the past, and it continues to be so, with 3% comparable growth in every quarter of 2024. Still, this is a great development since being GAP’s most stable brand means it also decreased in the years prior, just a little less than the other brands…

There is not much news about Gap's business. Management's message is basically, "Business as usual.”

Gap Global currently generates ~23.6% of GAP’s sales ($899m of $3.8b).

Banana Republic:

Banana Republic was the second-worst performer in 2023. While the numbers improved, there’s still no visible growth. Gap is still in the process of giving the brand a new image.

To achieve that, the focus is shifted toward social media and influencer marketing. Additionally, stores will be repositioned to new locations that better fit the target audience.

The next quarters will show whether this strategy can fuel growth. Judging by the track record of the other brands, I wouldn’t be surprised by improvements. However, it is hard to say how fast they will come.

Banana Republic currently generates ~12.3% of GAP’s sales ($469m of $3.8b).

Geographies

I’ve mentioned that Lululemon's growth numbers were “rescued” from global demand and sales because the US results were weak. Gap must rely on its regained strength in the US since it cannot offset weak US results with international strength.

You can decide whether this concentration in the US market is positive or negative. Currently, the US market is relatively weak, but that can change within a year or two. I don’t have a strong opinion on the geographic concentration, but I believe the US market will grow in the long run, so I wouldn’t see it as a risk. Success will be more dependent on good execution at the company level.

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Investment Case

Due to the strong third-quarter performance, Gap raised its guidance for the Full year of 2024.

Now, if we do the calculations and assume net sales grow 1.75% (the average of guidance), this gives us $15.16 billion. Staying conservative on operating income, assuming 60% growth, gives us $970 million, taxed at 26.5%, leaving us with ~$713 million in net income.

This would suggest a forward P/E of 13, slightly higher than the current estimated forward P/E of 11-12, which is normal since this is a rough calculation, and we only estimated 60% operating income growth instead of the guided “mid to high 60% growth range.”

Summarized, you get a 2.4% dividend yield and can buy a profitable business returning to growth for a P/E of 11-13x. However, while the next quarters could bring positive surprises, such as higher-than-expected margin expansion, longer-term growth will likely stay in the low to mid-single digits.

If we add a 2.4% yield to 3% growth and expect no multiple expansion, you’ll get a return of 5.4%, which is not that appealing.

If we assume that multiples expand to 15, the 5.4% return increases to 25% (assuming a current multiple of 12). So, with multiple expansions, you could get a short-term return of +30%.

While this is absolutely possible, I wouldn’t want to bet on Gap right now. The return is only attractive under the assumption of multiple expansion, and a single bad quarter or a slowdown in the growth trend, which can always happen in retail, would wipe out all good returns.

To me, Gap is fairly valued (for mid to high single-digit returns), considering the uncertainty about the longer-term outlook and the sustainability of the turnaround trend.

That’s it for now! I look forward to the next pitch!

Have a great day!

Daniel

I myself mention in my articles whether I think a stock is a buy at current prices. However, I also provide context, such as what I am looking for in a stock (hurdle rate), what risks I am willing to take, and what position size this stock will have in my portfolio.

Today, I want to tell you how the Buy and Sell ratings most people give hurt your performance.

The Psychology of Buy and Sell Ratings

A big part of how Buy and Sell ratings influence us is psychological. Here are the two main reasons why they affect us:

Cognitive Simplicity:

We tend to simplify complex matters to minimize cognitive effort. Uncertainty, which is inevitably part of an investment, is such complexity.

If we see a reasonably good analysis, we feel like we have a better understanding, but the more nuanced it is (and a good analysis is nuanced), the more uncertainty remains.

If we see a buy or sell rating instead, the situation suddenly seems a lot easier. Buy = Analyst expects good investment; Sell = Analyst expects bad investment

We are immediately more willing to significantly overweight the aspects of the analysis that were positive (if Buy Rating) or negative (if Sell Rating).

Confirmation Bias:

That last sentence might have reminded you of this bias, the confirmation bias.

We actively seek information that supports our existing beliefs and ignore evidence that contradicts them.

As soon as you see whether the stock was rated a buy or a sell, you focus on the information that supports that thesis.

(Of course, the same goes for the person researching the stock. If you know your analysis's result beforehand, you’ll find the evidence you need…)

Apart from the psychological side, individual circumstances influence how much risk we are willing to take and how much return we want to achieve.

Good Investment for Me; Bad Investment for You

The inevitable uncertainty is why we must assess investments based on their risks and possible rewards. But someone else’s situation might be totally different from yours. If so, the investments that fit your strategy differ from those that suit them.

In 2022, I interned in a Family Office. Family Offices have very wealthy clients who are mostly focused on steady, low-volatility returns. They don’t expect 20% a year.

However, if you’re just building your wealth, you should focus on higher returns and care less about volatility.

If you’re in your 20s or 30s, you have most of your career, and most of your “lifetime salary” is still ahead of you. You can take a lot more risk than someone in his 60s.

That’s a highly relevant point! Because of the above factors, I would be fine with allocating +40% to a single position. However, I would never advise my father to do the same. My risk with a 40% position is significantly lower than his.

Side Note: I’ve now added my cash position to my Portfolio. That way, the weighting of my positions is no longer "inflated.” As mentioned here, my investment activity will increase significantly this year; thus, I expect this capital to be allocated to attractive investment opportunities soon.

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How to use Stock Research the Best Way

Reading stock research is one, if not the best, way of studying to invest (besides investing on your own). I’ve read tens of thousands of pages on investing, but my biggest progress came from reading good stock research and doing it on my own.

Here’s how to use stock research and stock pitches to learn (and benefit financially) the most:

1. Know your Risk Tolerance

In almost everything I write, I give you my perception of the risks. Where can the stock go in the worst case? How does it compare to the possible returns?

If you know your risk tolerance (based on age, capital, psychology), you know exactly if the stock is for you.

2. Price Targets

In my valuations, I give you multiple possible outcomes (E.g. base-case, best-case, worst-case). Why? So you (and I) don’t anchor one price, especially the best-case scenario price, and thus break down the entire case only to that number.

Articles that only quantify the upside, not the downside, do not show the wide range of possibilities.

3. Position Sizing

If I consider a stock a “Buy” (after giving all the context above, of course 😉), I also include what position sizing I will give to the stock.

Some stocks have risk-reward ratios where they might lose 50-60% but could also go up 5x or more. While I mostly buy stocks with a significant margin of safety, sometimes I find a situation like this attractive. For other people, taking such a downside risk would be wrong.

However, those stocks would obviously not be the +40% position mentioned earlier.

You can see how a buy rating without the position sizing aspect makes little sense.

That’s it for today!

I hope you enjoyed this quick article. My next stock pitch (as can be seen in the schedule) will be published on Friday!

Best

Daniel

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“I have no original ideas. I’ve seen a filing by David Einhorn. And his largest position was a coal producer. And I just wanted to answer: Why is David Einhorn so hard and heavy on stupid coal??”

So, let’s keep the cycle going and see if we should clone Mohnish’s investment.

Mohnish accumulated a significant position of over $110,000,000 in today’s stock, which is +45% of his entire US portfolio. Two other positions from the same sector add to this bet.

Combined, they make up ~97% of his US portfolio. If one of the best investors bets this big and(!) the stocks haven’t moved yet, we should take a look.

Learning about this industry was interesting since I hadn’t encountered it before. However, I’m clearly no expert yet. I’ve come across so much more information that I’ll have to do a second part since I couldn’t fit everything here (and I still have some open questions I must answer).

Today’s article will help you understand the market and the investment opportunity. I’ll use Alpha Metallurgical Resources to show the possible upside of metallurgical coal stocks. In my second article, I’ll dig deeper into competitive dynamics, costs, and prices. I’ll also share a detailed valuation/financial model with you.

Alpha Metallurgical Resources is the largest US coal mining company specializing in metallurgical coal. I know… coal sounds ugly, but give it a shot! This company is not in a dying industry—quite the opposite.

Alpha Metallurgical Resources, headquartered in Bristol, Tennessee, operates 21 active mines and nine coal preparation and load-out facilities across Virginia and West Virginia. These operations are strategically located in the Central Appalachian region. AMR also owns 65% of the Dominion Terminal Associates (DTA), an export terminal in Norfolk, Virginia.

Here’s a quick Overview of what makes AMR attractive:

• Healthy Balance Sheet → Low (Fundamental) Risk

  • $485m in Cash vs. 3.6m in Long-Term Debt

• Well-run Company → Intelligent Management

  • Shareholder friendly → Bought back 30% of shares in the last 2 years

  • Skin in the Game → 11.27% of Shares held by Insiders

• Macroeconomic Headwinds → Very Cheap

  • Possible Bottom in the Cycle

  • Regulations created Oligopoly

• Option-Like Upside Potential

Let’s start with a short industry breakdown.

There are two types of coal: Thermal and Metallurgical. Thermal coal is used for electricity generation. Metallurgical (“met”) coal is used for steel production. It is higher in carbon and lower in moisture and is also referred to as coking coal.

The Process of Making Steel:

When making steel, the met coal is heated above 1000 degrees Celsius in a coking oven. The result is coke, which is then given into a blast furnace together with iron ore. Hot air and PCI are introduced and increase the temperature to over 2000 degrees Celsius.

This produces carbon monoxide, which, combined with the high temperature, converts the iron ore into a liquid. The liquid is then cleaned of impurities, and alloys are added. Voila—you have created iron.

Thermal vs. Met Coal:

The difference between met coal and thermal coal is important because it explains why AMR is not operating in a dying industry. Coal used for electricity is slowly decreasing and will face increasing long-term troubles (except for high-quality CV thermal coal, perhaps). However, coal used for steel production is a growing industry and will remain so for the foreseeable future.

Experts expect the met coal market to grow between 2% and 4% annually in the next five years, depending on the forecasts.

China is by far the largest consumer of met coal. Its weak economic situation, especially in the property sector, has been a major factor in the decline of prices in recent years. India is second on the list of consumers, and its demand is rising much faster than Chinese demand.

While the left chart makes it seem like India is still of little relevance, that’s not the case. In fact, for AMR, it is highly relevant since India is importing met coal at the same levels as China (both about 20% of total imports; 2022 numbers) and has accounted for ~37% of AMR’s export sales over the past five years. AMR doesn’t sell any of its coal to China. AMR is still dependent on the Chinese economy, though, due to China’s influence on met coal prices.

However, the weakening Chinese economy is not the only reason for the severe decline in coal prices. Part of the story is that prices in 2022 have been far above historical averages.

There are three main reasons for the outlier in 2022. The biggest has been the Russia-Ukraine war, which caused massive supply chain issues and general shifts in global trade dynamics. A longer-term trend has been the regulation regarding ESG, which (indirectly) caused many mines to close, thus creating a supply problem when demand shot up both after the pandemic and at the beginning of the war.

While the problems weren’t completely solved, demand flattened due to the Chinese economy and countries adjusting to the new circumstances. China’s lower demand for steel, and, hence, met coal, hurt the market in two ways. First, Chinese imports of met coal went down, and second, China dumped its overproduction onto the market. This caused prices to come down significantly. Accordingly, the profits of met coal companies like AMR also declined.

If you look at AMR’s revenue and net income chart, you can see the resemblance of the met coal price chart. It’s relatively easy to see that investment success with AMR is primarily dependent on the met coal price.

Thus, we need to find out where in the cycle met coal currently is, where prices could go, what that would mean for AMR’s profits, and whether AMR (and we as potential investors) can wait that long. One of the biggest risks with cyclical companies is that the downcycle lasts longer than expected and that companies do not survive it. (From an investor perspective, you also have potential opportunity costs as a risk.)

Where in the Cycle are we?

As always with cyclicals, many factors influence a cycle's duration. So, there is no exact, fixed duration for these cycles. However, we can try to estimate where we are by looking at historical patterns.

Looking at historical prices can be a bit confusing at first since there are different grades of quality for coal and thus different prices. The market standard is the price index for “premium low volatility hard coking coal.” In the chart above, we look at “Australian low vol PCI.” We can see lows in 2014-2015 and then again in 2020. A visual analysis might suggest that we are in the middle of a cycle right now.

If that were the case, the investing opportunity would involve some risks. Yes, AMR is very cheap (see below), but we wouldn’t know how low coal prices will go or how big the impact on AMR’s financials will be. If, however, we are close to the bottom, then we have a company that is extremely cheap, financially perfectly healthy, and ready to benefit from all the price increases in the next upcycle. And I think there are signs that could show we are at such a bottom.

Read more

While the portfolio below covers all my current investments, I have a relatively large cash position (not large in absolute terms, unfortunately…). Over the course of this year, I want to invest that money in both current and new investments.

Let’s go through the holdings now, discuss updates if there are any, and then how I plan to proceed with the company/holding.

Flow Traders ( )

Flow Traders is currently my largest position, with a ~35% portfolio share. However, because of the cash position, the weightings of the holdings do not reflect my conviction in the company one-to-one. That’s why we’ll also discuss the outlook of each position today.

The Flow Traders position became my biggest holding because I got the opportunity to invest at good entry prices. These grew the position, and it performed well from there.

Business News:

We have had no updates from Flow directly since the last earnings report, which I covered here:

So, let’s look at the most important indicator for Flow’s business: volatility. This can give us an idea of how the next quarter might look.

As you can see, the overall level is still low. We had a short spike at the end of December, reaching 27.6, but most of December showed extremely low volatility. October and November were slightly higher, at a level between 19 and 21.

However, in the above-linked article, I calculated with only €0.35 EPS for Q4 based on the Q4 results of 2023. As I said then, this was a conservative estimate, and this claim should hold true. In Q4 of 2023, the Vix was mostly around 12. Thus, I expect €0.35 at a minimum, giving us a P/E of 8.

My View:

You must consider the following regarding Flow Traders: Flow is a company with a very asymmetric risk/reward profile. When the markets become volatile and go down, Flow thrives.

I could buy Flow at low valuations (avg. Buy-in: ~€16), which further reduces risk. At the same time, the market environment is already the worst case for Flow, although they did a good job navigating this market.

That’s a good setup. Low entry prices + current market environment = Downside limited, and surprises should be to the upside

However, if the market maintains its low volatility for years to come, Flow is unlikely to produce outsized returns. So, the risk is opportunity costs. 

You know me. I’m not a macro investor. Still, I believe it’s realistic that there will be more or less severe market setbacks in the near future (could be in a month from now, could be in three years), which leads to my conclusion.

Conclusion:

I want to hold a position in Flow for that scenario. However, it will not be as large as it currently appears. I aim for 20% annualized returns, and that’s tough to achieve if a position that acts as a hedge against market turmoil (in this market environment) plays such a big part in the portfolio.

Because of Flow’s nature, a 5-7% position should be ideal for me. If we see a market downturn, the returns will be huge, and a 5-7% position is enough to have a significant impact on the portfolio. At the same time, this position size doesn’t hurt returns too much if the market keeps increasing.

Does this mean I sell stock? No, I will use cash inflows this year and the cash I currently have to build up other (and new) positions, so Flow will naturally shrink.

Alibaba ( )

Here we go again…😏

Let's start with some news and updates before we discuss my view of the future of my Alibaba investment.

Business News:

Unsurprisingly, Alibaba (and China overall) has had some news since my last update. Here’s a short overview:

1. China's 10-Year Bond Yield is at Historic Lows

   China’s interest rates have collapsed recently, increasing the deflation and currency problems. Experts expect the rate to go even lower, closer to 1%, since the real interest rates are still too high compared to historical averages.

   

   While this is generally bad news for the economy, bad news might be good news right now in China. Sounds confusing, I know. But here’s why → A worsening macro environment forces the government to act and deliver more stimulus. And stimulus is what drives Chinese stocks at the moment.

   Since Alibaba’s stock didn’t react to the macro news either, and we’ve been in the same range for over a year now, it also feels like we are at a bottom where surprises, if they come, are to the upside.

   However, this should not downplay the risk of deflation or a weak yuan, which could severely impact Alibaba’s fundamentals. I’ll keep you up to date.

2. Selling Businesses

   Alibaba also sold two smaller parts of its operations. A stake in a department store chain named Intime for $1 billion and a stake in the hypermarket chain Sun Art for $1.58 billion.

   In my opinion, it is a good decision. Technically, they’re realizing a loss of $3 billion combined over both sales, but it shows that they’re back focusing on what works, slimming down operations and shutting down loss-making businesses.

3. Price reductions for Large Language Models of up to 85%

   Alibaba continues on its journey to reduce prices in order to win market share. They did the same with the cloud, which seemed to work pretty well (see latest update). Let’s see if it works here as well.

My View:

I know many people hold a grudge against this company—especially those who owned it for a while. I don’t have the same feeling. Although I have thought about and discussed this investment a lot in recent years. So much, there’s an argument to make that a good investment shouldn’t cause so much “worry.”

And I can’t deny that I’m conflicted. My average buy-in price is $78, and, as I have often mentioned, I traded the stock in the range between $80 and $110. This has allowed me to earn a decent return on my Alibaba stock.

Unfortunately, I don’t know the exact returns since I concentrated all my investments in one place now but traded Alibaba stock on another broker due to cheaper transactional costs. If I subtract all the costs and taxes involved in the trading, I probably made less profit than it felt 😅.

Rough Calculation: For perspective, I traded with 50% of my overall BABA position. When I compare the start value of my BABA position to the end value, I should’ve made a net return on my position in 2024 of ~15-16%. Compared to the ~12% Alibaba returned in 2024 (if held without trading).

I take that. However, as with every other investment, you must compare this to all alternative investments you could’ve made. Doing so, it doesn’t look that great anymore.

Be that as it may. Alibaba remains incredibly cheap on a fundamental basis (I had to include the charts below… sorry), and we seem to be at a bottom in the $75-$80 range. The Setup: minimized downside risk (on a fundamental basis), and most surprises should be on the upside.

(For all new readers, I differentiate between a fundamental and a macro margin of safety with BABA. Fundamentally, you have a huge margin of safety, thus limited downside. If you believe, however, that a war with Taiwan is possible, there is obviously no limit to the downside. For details here, check recent articles.)

So what to do?

Conclusion:

Read more

Over the last few days, I took time to reflect on my investing strategy - the things that went well and my mistakes.

I like a critical look at my investing strategy, so today, I want to focus on the points that I want to improve in 2025. I‘ll make another list next week with all the points that worked well and that I want to keep doing.

But for now, let‘s look at what’s there to improve:

1. Momentum Matters

In years like this, when the market only knows one direction, it's tempting to abandon your strategy and chase the hype surrounding top-performing industries and companies.

That‘s not my style.

I generally think this stubbornness is needed to have long-term success. However, I also realized that being too stubborn in your approach (or, put differently, not adjusting) can hurt your performance.

My stubbornness shows in my tendency to ignore momentum too much. I buy stocks that I consider mispriced and usually give them two to three years to play out.

Judging by history and the experience of many of the greatest investors out there, it takes two to three years for the market to realize its mistake. That sounds great. But this works better in theory than practice. Why?

Because markets are more efficient than we want to give them credit for. “If it’s too good to be true, it probably isn’t true.”

And whether you find a reason for the stock being cheap or not, it’s better to be on the safe side and make sure to have a reason for it to become fairly priced again - a catalyst. Catalysts create movement, which in turn creates momentum.

I underestimated momentum in past investments. And it was costly this year.

My Learning: Focus more on Catalysts and Inflection Point Businesses

2. The Right Moment to Sell

All of my stocks were higher at some point in 2024 than they were at the end. For some stocks, this means I can buy them cheaper and accumulate a larger position. For others, it might mean I missed the moment to sell.

It‘s a serious mistake if you knew better at the time but ignored it because you tricked yourself into thinking there’s more to come.

Of course, you could always say in retrospect that you knew better. However, since I write down the thesis for every investment case and what needs to happen for me to sell, I can check whether I actually knew better at the time.

Sometimes, I ignored my own “Sell when this happens…” category and saw the shares decline afterward instead of taking the profit.

My Learning: Act on your Thesis! Not every company turns into a compounder!

If your investment case worked out, stop trying to justify to keep holding the stock.

3. Your Investing Strategy Needs to Fit YOU

As you all know, I wanted to transition more into micro-caps this year. And I did do that with my research. However, it takes a lot more time to research microcaps and keep updated on them. Time, I unfortunately have not always had this year.

This resulted in fewer investments and, I’m sorry for that, fewer pitches and content for you.

Why does this point matter for my investing strategy? Because it made me realize that you need to be realistic and honest with yourself. I liked the idea of microcap investing so much I wanted to force the change.

In reality, a more balanced mix of micro-cap and mid- to large-cap stocks would’ve resulted in more opportunities and more content for you.

My Learning: Find what works for you and be realistic about limitations!

As I have mentioned to the Paid Subscribers already, starting in late February, I can spend much more time researching stocks. Together with the new Community, I believe this year’s lessons will be very helpful in 2025.

More information (for Free and Paid Subscribers) on “The Intrinsic Value Podcast” Community will be available tomorrow!

Schedule for the Next Posts:

• Updates on the New Community (Tomorrow)

• Portfolio Update and Recap (Next Week)

• New Stock Pitch (The Following Week)

  ---

Best

Daniel

Despite being one of American history's biggest entrepreneurial success stories, its stock has seen better times. It’s down 56% from its 2021 All-Time High and ~27% YTD. Decades of outperformance have (for now) come to an end, and at 78$, the stock hasn’t delivered any returns since 2018 (if you would’ve owned it without buying or selling).

But what happened to Nike? Is this the downfall of the sports giant, or is it an overreaction of the market, which is scared of short-term macroeconomic headwinds?

If you ask Bill Ackman, billionaire investor, founder, and chief executive officer of Pershing Square Capital Management, he would say the latter. Nike is now one of his largest holdings and represents +11% of his $12 billion portfolio:

This feels like a good time to discuss Nike and see whether Bill Ackman or the market will be proven right.

Let’s start by understanding why Nike, both the company and the stock, has been struggling lately.

The Nike Downfall

There are multiple reasons for Nike's recent problems. Some are more long-term and concern the company level, while others are short-term factors that primarily caused the latest stock sales.

Long-Term Strategy and DTC Focus

In 2017, Nike decided to focus more on its DTC business, Nike Direct. The idea was to cut costs, improve margins, and simplify the company’s operations. Part of the DTC strategy was to cut ties with retailers and thus drive more customers to Nike’s websites.

That strategy has proven effective, especially during the pandemic. Nike benefited from the online shopping boom and the tailwind of an increasing interest in sportswear.

In recent years, however, growth has slowed significantly. In part, this is due to the general decrease in consumer spending. However, Nike’s DTC strategy also has an effect here. A more price-sensitive consumer is more likely to pass on an expensive Nike shoe and instead look for cheaper models or discounts in a nearby retail store.

With Nike gone, other shoe and apparel brands have taken Nike’s spot in local retailers. The management might have underestimated the importance of retail stores, especially in weaker economic times.

Brand awareness is another factor. Sure, everybody knows Nike. However, retail stores are also effective and relatively cheap marketing machines. Retail stores market their best-selling products. Nike has been that product for almost every retailer in which it was sold. By leaving the stores, you also miss out on the store’s marketing for your brand.

Nike has admitted that mistake and has been increasing its wholesale presence again since last year. However, getting back in has not been as easy as they might have hoped. Previous customers who agreed to sell Nike again have ordered less than before due to a weak consumer environment and the strategy shift to become less dependent on a single brand. They are more diversified now, resulting in fewer Nike orders than before.

Macroeconomic Factors

Inflation and Consumers

I’ve mentioned the weak consumer several times now, and that’s one of Nike's main problems. Premium brands also demand premium prices, and Nike is no exception.

Rising raw material and labor costs due to global inflation have significantly increased production expenses. Materials such as rubber and synthetic fibers, critical for shoe production, have become more expensive.

To keep margins stable, Nike raised its prices. This has worked for years. But since the pandemic, Nike has to realize that when the middle class starts struggling with grocery prices, $200 sneakers might not sell as well anymore.

Geographies

I’ve heard that Nike mostly struggles because of its China business and the macro problems there. However, if we look at the numbers, that's not the case.

Last Fiscal year, China was the second-best performer with 4% revenue growth, while North America was the worst with a 1% revenue decline. Overall, Nike is struggling in all its geographies, which is unsurprising since most macroeconomic headwinds have been global phenomena (with some local exceptions, like the war in Ukraine).

Problems on the Business Level

Competition

The combination of high prices and the “retreat” from wholesale has created new and strengthened old competition. In recent years, multiple brands have emerged that are giving Nike a run for its money (pun intended).

A look at Lululemon’s financials shows that the weak consumer is not the only one responsible for Nike’s performance. The competition keeps growing. Of course, growing from a smaller base is easier, but Lululemon is a company with nearly $10 billion in revenues. It’s not a small brand anymore.

Despite that, we actually see a larger difference in growth rates in recent years than in 2017 or 2018.

Lululemon is also a great example of a bigger change that I see in the apparel and show market: Trends work differently today.

Lululemon is not cheap at all. In fact, Nike products are often cheaper than Lululemon’s (Nike lost the price-sensitive consumers by raising prices and the less price-sensitive consumers to more specialized brands. More examples later).

Lululemon is a great example of how a modern brand can be created and grow quickly. The keyword is social media. I know… this is not an astonishing revelation. However, I mean a certain and newer use of social media.

Nike is by far the most followed sports brand in the world, but it has failed to create big and long-lasting trends for years. Trends in today’s world are far more short-lived than they used to be, and they rarely come from established brands anymore.

Back in the day, Nike could put out a certain shoe or clothing line and dominate trends or styles for years. Today, the world is a lot faster. A big following is not the way to get exposure anymore. It’s about temporary trends that spread quickly and far.

It’s the TikTok influence on the fashion world. Lululemon benefited from that and evolved from the niche yoga market to the broader sports market. Shein emerged like that, Crocs or Abercrombie&Fitch rebranded through social media campaigns, and many more will come up in the future.

Being a small (or struggling) company can even be an advantage in this scenario. As companies grow, they become less flexible and less likely to create the next big trend. Nike is experiencing this firsthand.

Other Competitors

While Lululemon is one of the bigger competitors in the apparel business, companies like Hoka (one of many) are putting pressure on Nike’s shoe business. Once again, they’re not cheaper than Nike, but they’re more explicitly targeting Nike's “bread and butter” customers, runners. They deliver what Nike failed to deliver in recent years: innovative shoes. With sales of ~$2 billion per year, they are significantly smaller, but Nike needs to take the competition seriously and draw the right conclusions.

The risk isn’t to get replaced by a single big company. The risk is losing market share in all of their product segments to many smaller but more specialized brands.

While all this sounds pretty negative, my perspective on Nike’s future is less dark. The flip side of the new trend mechanisms is that companies that are built on those quick hypes are often short-lived. Nike persists, but most of them don’t.

I also believe that Nike will create new trends in the future. Their innovation has been poor lately, and they know that, which is why they have made management changes and are working on a new innovation cycle.

Management (Decisions)

In October 2024, Nike appointed Elliott Hill as CEO, succeeding John Donahoe. I’m always cautious when it comes to judging the management of multi-billion dollar corporations. They have diversified operations that make it difficult to assess how good a single manager/CEO is.

In this case, however, everything seems like this is the right choice. Donahoe came off as a consultant, and it didn’t seem like he understood what Nike stood for. Hill brings over three decades of experience within the company. His career at Nike began in 1988 as an intern, and he has since held 19 different roles, culminating in his position as President of Consumer and Marketplace before his initial retirement in 2020.

His job now is “revitalizing key product lines,” which is business English for making better products again, strengthening relationships with retail partners, and reviving the Nike company culture that supposedly suffered under Donahoe.

Recent Financial Results

We’ve now talked about the problems Nike had. Let’s look at the financials and see how big the impact actually has been.

In the results for the first quarter of the 2025 financial year, we see weakness throughout all channels. Revenues overall are down 10%. Nike Direct, the DTC operation, saw a revenue decline of 13%, and wholesale also declined by 8%.

Nike’s profitability took an even bigger hit, with diluted EPS down 26% YoY. This has been the weakest quarter since the Q1 of the 2023 Fiscal year revenue-wise. Profitability-wise, even longer.

Perhaps even worse for the stock has been the announcement by CFO Matthew Friend during the earnings call to withdraw the full-year 2025 guidance due to the “transitional period” Nike is in and postponing the investor day presentation. Instead, Nike will release quarterly outlooks.

Generally, Nike already hinted at a continued weakness in almost every product and channel as part of the “plan” to refocus on innovative products instead of the classics and rebalance sales channels.

These excerpts give you an idea of the narrative in the earnings call. If this wouldn’t be one of the greatest brands in the world and a company that has proven for decades that they know how to do business, I would be highly skeptical of the “planned” decline.

However, it can make sense in this case since we already discussed that the measures they now take, more innovation and refocusing on retail, are necessary.

To put all of this into perspective, let’s take a look at the bigger picture and see if the last couple of quarters are such a disaster as they seem to be.

The Bigger Picture

If we look at the long-term chart for Nike’s revenues (similar picture for earnings), the current “decline” is almost invisible. We have seen slower growth since 2022, which was also caused by a normalization after the pandemic boom.

We need to answer whether we see a continuation of the trend of the last quarters (so further decline) or a recovery to the long-term growth trend. Answering this question is what makes or breaks Nike’s investment case.

In my opinion, Nike’s brand strength and the operational infrastructure they have built will be a moat that shields off the competitive pressure that is certainly there and getting stronger in the future. Add in the new measures taken by the new CEO; I agree with Bill Ackman that Nike can return to its long-term growth trend.

However, the second important component (besides the “value” or state of the business) of an investment case is still missing—the price you have to pay.

Valuation

As you know, I spent more time looking at small and micro-cap companies, so I haven’t really noticed the massive Nike selloff. I only came across it when I checked some of the superinvestor's newest buys and sales and saw Ackman’s position.

Looking at the stock chart, I thought Nike might be a huge bargain right now. After digging in, I think the picture is not as clear.

The company is currently trading at historic lows. However, historic lows for Nike mean a P/E and P/FCF of 21-22x, not necessarily bargain level.

I think the valuation is quite simple today. Nike trades at a pretty fair price right now, considering the uncertainty around their results but also the fact they’re still producing lots of cash ($6.6bn FCF last year and +$7bn this year).

However, using models like a DCF or reverse DCF makes little sense right now since the cash flow has been volatile in recent years (between $4bn and $7bn), and there will be even more volatility ahead of us.

Modelling from this base is nothing but a guessing game. I know, though, that many of you would like to see such a model. Thus, with the disclaimer in mind, I’ve used the rough average of $5bn FCF for the model below. It showcases pretty well where a Nike investment would generate its returns from:

Looking at this model and the three different scenarios, what would you think is the main driver of returns?

It’s the multiple. Here’s what this model would look like if I assign the same multiple in all three scenarios:

In the first model, you see a difference of $55 between the best and the worst case. In the second model, the difference is only $30.

I believe Nike will manage to recover in the long run after experiencing a tough 3-5 next quarters. Your returns will then come from the multiple the market gives to Nike. Will investors accept Nike as an American premium business again?

If so, Nike will become a double as soon as results recover and stabilize on a higher base.

If not, even a business-level recovery will not deliver outstanding returns, as seen in the fast recovery scenario of the second model. However, Nike is also paying dividends and buying back shares. Both can make the time waiting for a recovery more lucrative.

Conclusion

I believe Nike deserves a premium valuation! It’s trading at a fair price right now, but if the business gets back on track, I wouldn’t be surprised to see Nike trading at $120-$130 relatively quickly after.

You have the risks of more competition, though, and this will be a bigger problem in the future than in Nike’s past. Let’s see how they execute in the quarters to come.

When looking through some superinvestors' portfolios, I had the idea of starting a series where I quickly analyze their portfolio’s biggest holdings. Would that be interesting to you? Let me know!

That’s it for today!

Daniel

If you know me, you know I usually do not trade stocks. I make exceptions in positions I hold for the long term to take advantage of price movements. I would not trade positions that I do not consider long-term holdings. There are two main reasons for that:

1. Just because certain price ranges could be observed in the past doesn’t mean they will continue to exist going forward. If it’s a long-term position for me anyway, doubling down when it gets cheaper makes sense either way. If you trade a random stock, you might get trapped in a bad investment.

2. You’ve analyzed and observed long-term positions much more rigorously than other stocks and understand price movements better.

There’s truth in the saying that you only know a stock when you own it. Thus, when I see similar patterns (price ranges) in stocks I have owned for many months or years, I, here and there, try to take advantage of them.

I mention this again because I see even more difficult times for Chinese stocks after the US election, not because of the policies that Trump might introduce—I don’t know what will happen, and I don’t think anyone does—but because a sentiment change towards China will become even more difficult now.

But now, let’s get to the Q2 2025 Earnings (Alibaba is a bit ahead of us 😉):

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Earnings Overview

Alibaba Group Holding delivered mixed results, missing on the top line but outperforming significantly on the bottom line:

• $33.7 billion in revenue, up 5% (Miss by $500 million or 1.5%).

• $2.59 in GAAP diluted EPS, up 63% (Beat Estimates by $1 or 62%).

• $2.15 in adjusted diluted EPS, down 4% (Beat Estimates by $0.10 or 5%).

• $4.4 billion in operating cash flow, down 36%.

• $1.95 billion in free cash flow, down 70%.

The cash flows have been lower due to Alibaba's investments in the quarter, but we will get to that.

Segment Overview

Looking at the segment results, we can see a picture similar to the last quarters. The market saw it in a similar light and didn’t react decisively in any direction. However, since JD, a close competitor of Alibaba, had reported disappointing results a day before, BABA's stock was also punished by the bad overall sentiment.

Without further ado, let’s dive into the details of the most important segments and see whether these numbers are a positive or negative sign.

Chinese E-Comerce - Taobao & Tmall

At first glance, revenue growth of only 1% doesn’t look good for Alibaba’s most profitable and important business. However, considering the current macro environment and the reason for the slow revenue growth, I think it looks worse than it is.

It’s not that fewer people order from Taobao or Tmall. Alibaba reported double-digit order growth year-over-year. However, this is not shown in the revenue numbers since the average order value decreased.

While this doesn’t help Alibaba right now, it will when the Chinese consumer strengthens again, and the average order value increases again. Then, we will see the growth caused by the higher order growth reflected in revenues.

The same goes for the 5% decline in EBITA margin. It doesn’t look too good without context, but considering market conditions and, more importantly, Alibaba's investments in the business, I’m okay with that result.

Cloud Intelligence Group

The cloud business is the positive surprise in the earnings in my book. Top line growth of 7% despite the strategy shift in recent quarters to cut out low-margin products (non-public cloud products), which have been the largest part of revenues, and an 89(!)% EBITA increase.

It looks like the new strategy is working pretty well. What’s even better is that we can finally see a long-term strategy and direction for the cloud business after many quarters of uncertainty and obvious differences of opinion, even within the company, as evident by the management changes.

The reason for the still relatively low overall EBITA margin for the cloud business of 9% is the investments made into cloud infrastructure and, of course, AI products. In Alibaba’s case, however, the AI investments definitely make sense:

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International Digital Commerce Group

From good news to mixed news. Alibaba's AIDC businesses have been growing rapidly in recent quarters, and they still do, with 29% revenue growth. However, profitability is further away, with EBITA margins dropping again.

I’m fully aware that growth comes at a cost. However, I think it would be wise to keep an eye on the losses in this segment. Alibaba’s investment thesis is its fundamental strength and the huge cash flows it still produces. The times where growth is the main thesis are long over.

In a situation of relative weakness, I would like BABA to focus primarily on the fundamental soundness of its operations rather than growth at all costs.

This is not yet concerning, but I wouldn’t want to see EBITA margins slide further going forward.

Cainiao Smart Logistics Network

Cainiao had a similar fate, with EBITA down to almost breakeven due to increased investments in cross-border fulfillment solutions.

Local Services Group

The Local Services Group had a good quarter, with 14% revenue growth and 85% EBITA growth. The improved margins are due to improved operating efficiency and scale, which means that we should expect further improvements going forward and might see profitability soon.

Digital Media and Entertainment

Not much has changed in this segment. Revenues are mostly flat, and EBITA improved slightly by 11%.

All Others

Now, to my favorite! Okay, irony off. The still weird “All Others” segment delivered an “okayish” quarter, growing top line by 9% and decreasing EBITA by 10%.

Not much to say here and not much info anyway.

Share Buybacks

In this quarter, Alibaba bought back shares worth $4.1 billion, which is less than in the preceding quarters and results in a 2.1% net reduction of shares. The management explained this slowdown by taking a strategic approach to buying back shares when they’re at the bottom.

Considering the rally in October, they probably reduced buybacks at that time. Kind of like the strategy I described at the beginning 😉. Considering the remaining $22 billion in the share repurchase program, I think we’ll see increased buybacks at the current prices.

Conclusion:

As mentioned, it was a mixed quarter. Some businesses were still experiencing macro headwinds, and others, namely the cloud, surprised on the upside.

Going forward, I think it will remain tough for Alibaba and Chinese stocks as a whole for quite some time. I do not see near-term catalysts here. The October euphoria burst quickly after the new stimulus wasn’t as expansive as the market wished.

To be honest, I think the CCP couldn’t have done much more. The market expected too much, as it wanted to see a huge rally fueled by huge stimulus packages.

If we see regular stimulus that supports the underlying economy, the overall picture should eventually get better. With macro headwinds gone, we could finally see if the investments and underlying improvements of companies like Alibaba pay off.

Alarum will report earnings tomorrow. I know some of you, including me, are interested in how they will look. I’ll also cover them here.

That’s it for today!

Best

Daniel

Was it a good deal?

Liberty Global shareholders have now received the Sunrise shares. I must admit that I was a bit confused when my Liberty Global position was suddenly 40% down yesterday😅. It took me a minute or two to realize what day it was.

Liberty A stock is now trading at $12.42, and Sunrise stock is a bit over $50 (Update: now trading at $46.45; naturally, still very volatile).

Depending on the exact close and open numbers you got, the breakeven prices for Liberty and Sunrise stock should be $10.99 for LBTYA and $48.75 for SNRE shares.

I arrive at this by taking LBTYA’s closing price before the spinoff, $20.74, and subtracting the opening price of $10.99. This gives us $9.75, which we multiply by 5 due to the ratio of LBTYA to Sunrise shares. This gives us the price of $48.75 for SNRE shares.

What Now? What are the fair values?

As mentioned, both LBTYA and SNRE shares currently trade above these values (Update: SNRE is currently lower, as mentioned above). However, this raises the question: What do we do now? Hold the SNRE shares? Sell them? The same goes for LBTYA shares.

Since today, SNRE shares will trade on the SIX Swiss Exchange, which should bring more volume and paint a clearer picture of how the stock will be valued in the next couple of weeks.

I consider SNRE’s fair value much higher than $50. In one of its reports on the spinoff, Liberty Global said that after the deleveraging, which we discussed in prior articles, future FCF should be about $460m and the payout ratio 70%+. This would result in $320m+ for dividends, divided by the share count of 72.43m shares; this is a $4.45 dividend or a ~10% dividend yield (on current prices).

Investors get a high-quality business with a double-digit dividend yield. That’s a unique proposition on the Swiss market, and I’m confident it will eventually drive the price up. I would sell in the range of $65-$70.

For Liberty, the thesis remains largely unchanged since this was only one of the many ways to deliver value to shareholders. The main part of the thesis remains the buybacks. If you want to read more on that, read my initial pitch:

If you have any specific questions, please ask me on Discord, either in one of the community channels or in private (only for paid subscribers)!

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Italmobiliare - Q3 Report

Caffe Borbone

Caffe Borbone operated in a very tough environment in 2024. The prices for raw materials (coffee beans) reached all-time highs. Robusta reached 5.50 dollars.

This obviously impacted margins. However, with an EBITDA margin of 21% and an EBIT margin of 17%, Borbone still performed quite well. I’m not at all concerned in the long term.

Borbone remains a very strong brand and business for ITM and is essential to its future success.

Santa Maria Novella

Santa Maria keeps on delivering on promises. Revenue growth reaccelerated again (26%), pushed by 43% growth in retail sales and 30% growth in E-commerce sales. ITM didn’t give much information on the Japan expansion, but it seems it was very successful, and Santa Maria had no difficulties getting into the market.

Those are very good news since Asia is and will be hugely important to the luxury market, and Santa Maria shows it can expand internationally without any problems.

Margins are also impressive, considering the expansion expenses and overall luxury downturn in 2024.

Italgen

Italgen is in the process of delivering a phenomenal year. Revenues grew 26% YTD, and margins more than doubled YoY.

However, the 2022 and 2023 results also looked worse than they were since the regulatory price caps lowered revenues and margins. On top of that, rainfall was historically low, while the first nine months of 2024 have been extremely rainy, benefitting Italgen.

And as bad as such a climate change would be, I think it might be a long-term phenomenon and tailwind for Italgen.

Casa della Salute

CDS again showed phenomenal growth (53% revenue growth), fueled by new acquisitions and openings. In Q3 alone, 3 new clinics and a new surgery theatre were completed, for a total of 6 new structures in the year.

Like-for-like sales growth has been 17%, showing the effectiveness of clinics. EBITDA growth YoY stands at 69%. I guess it will still be a rather long time until CDS reports profitability, but looking at the underlying business model, I’m confident it is a great business that deserves all the investments.

Sidi Sport

Sidi Sport remains in the process of restructuring. However, 2024 results show that it’s heading in the right direction. Revenues grew 23% due to strong performance in European markets and product-wise, especially in the motorbike market (26% growth).

The necessary investments in personal, new projects, etc., decreased margins, though.

Capitelli

Maybe you remember the swine fever that broke out in some regions of Italy in the last years. This has been a huge questionnaire for me regarding Capitelli. How big will the impact be? How bad will it get?

Well, by now, we can definitely say that Capitelli is incredibly resilient. Capitelli reported revenue growth of 5.1%, and margins seem to be recovering and outperforming the 2022 and 2023 margins.

Still, margins have again been impacted by high raw material prices and price decreases linked to swine fever.

In the long run, I expect Capitelli to come close to 2019 and 2020 margins again.

Bene Assicurazioni

Bene has reported excellent premium growth numbers again (33%). The growth was primarily driven by the Motor insurance sector, which represented 70% of the business and contributed 80% of total growth.

Strong sales channel performance across the board:

• Agency Network Channel: 29.5% growth YoY

• New Agencies: 24 net openings compared to last year

• Partnership Channel: 66.7% growth

Tecnica

Tecnica struggled in 2023 from the aftermath of the pandemic. However, it has since failed to recover, and to me, it seems like there are deeper problems within the business than just the covid aftermath.

It remains an important cash flow generator for ITM, but the worsening rather than improving situation is not a good sign. I hope we will get some structural changes or at least long-term plans for the business to get back on track.

Iseo

Iseo is another company that is not doing well right now. Problems with the new ERP system caused production and logistic problems, which in turn delayed revenue.

However, it seems that those problems were mostly fixed in Q3. Turnover grew by 11.7% compared to the same period last year, and revenues decreased only by 3.9%, which suggests that revenue losses have been almost absorbed.

The graphic below shows how much better the financial position now looks compared to H1 2024.

Callmewine

Last and least ;) Callemewine reported another bad quarter, and it is becoming increasingly clear that the business model is not working. While the financial impact on ITM is negligible, it still confuses me why ITM holds onto this company.

There are no signs that ITM is considering selling it. According to ITM’s report, not only Callmewine but the wine and spirits market as a whole is facing some uncertainty right now. While that might be, I think Callmewine’s business model alone is problem enough.

I’m not saying it cannot work (I think it is a very interesting model), but looking at similar models like Nakedwine, we can see how tough the business is.

Okay, that’s it for the two updates today!

Have a great weekend!

Daniel

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I must admit, looking at the numbers, the big jump surprised me a bit at first. However, it is about perspective.

Overview:

• 167 new stores (Q1-Q3 2024)

• 10.6% YoY Revenue Growth; 13.5% YoY from Q1-Q3 2023 to Q1-Q3 2024

• 3.7% YoY EBITDA Growth

• EBITDA Margins of 8.9%; Down YoY by 0.5% but 1.5% higher than in Q1 2024

• Like-for-Like Sales Growth 4.9% (expectedly lower than last year, but outperforming competition by far)

• Massive Debt Reduction (Net debt / EBITDA ratio of 0.25x compared to 0.41 Q3 2023)

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Okay, let’s go into the details of the numbers and make some comparisons with competitors since I believe that the comparison with competitors is what primarily caused the significant stock increase.

Like-for-Like Sales Growth:

LFL growth is one of the key metrics for retail stores like Dino. If you want to learn more about it, it’s best if you read out my initial stock analysis of Dino:

At first glance, Dino’s Q3 LFL growth looks weak compared to the historical numbers, especially in the last two years. However, the inflation and, even more importantly, the food inflation numbers provide important context.

Inflation came down significantly in 2024, and thus, the tailwind (although not good in general) for LFL sales was also stopped. Comparing the 4.9% to last year’s numbers doesn’t make any sense. What is important is that LFL sales growth outperformed food inflation by over two percentage points.

The results look even better when we compare them to Dino’s main competitors, in this case, Biedronka. They have reported the second quarter of negative LFL sales growth after another.

EBITDA Growth and Margins:

The year's second quarter was likely to be the worst due to price wars in the Polish market (especially with Biedronka and Lidl), food basket deflation, and rising labor costs. It seems that has been the case, and the remaining year, and especially 2025, will see a recovery.

EBITDA margins have recovered significantly already and, as you can see, outperformed Biedronka by more than 1%.

Balance Sheet and Debt Reduction:

Dino has reduced its (long-term) debt position by 41% YoY and now has a Net Debt / EBITDA ratio of 0.25x.

For comparison, we can again take Biedronka or, better said, its parent company, Jeronimo Martins, which not only did not decrease but actually increased its borrowings and net debt in 2024.

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Cash Flows and Investments:

Net cash flow from operating activities was up 27.8% YoY and 15.8% YoY between Q1 and Q3.

In good old Dino Polska style, most of the operating cash flow is immediately reinvested into the business, primarily in building new stores. Net cash flow from investing activities is up 60.3% year over year and totaled PLN 433.1 million in Q3 2024.

Over the nine months of 2024, Dino reinvested over PLN 1,168 million back into the business (~70% of total operating CF).

Conclusion:

The market punished Dino Polska in 2024 a lot more than it deserved. The stock went down around 10% after the challenging Q2 results and another 10% after competitors reported weak numbers and revised forecasts.

Dino was basically punished twice for the same thing. After those price decreases, Dino was definitely oversold, and I believe that’s why these numbers were enough for a 14% price increase.

Overall, it’s getting clear that the worst times are over, and, most importantly, Dino remains on its growth trajectory and is gaining market share from its competitors.

I’m happy with the results; they fit into Dino Polska's narrative of being a long-term compounder and show the management's great execution and long-term plan.

That’s it for today! Have a great Sunday!

Daniel

Since Wednesday, we have also learned that Trump will be the 47th President of the United States. What seems to be very good news for the overall market, at least in the short term, is bad news for certain industries.

One of them is the cannabis industry, which Trump has been a critic of in the recent past. The first reaction of many cannabis stocks, thus, was a selloff.

What can become a tangible problem for US cannabis companies shouldn’t cause struggles for a company that doesn’t have any business in the US.

Like the company we discussed last week…

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One of the most used words in investing, especially in the value investing community, is the word: Contrarian.

“Contrarian investments outperform the market.” 

“The most successful investors are contrarians.”

"Contrarians buy what others fear and sell what others envy."

…

These narratives about contrarianism have been repeated and reinforced over and over.

But is that actually true?

These thoughts are based on Benjamin Graham’s core ideas of value investing. 

It’s based on the simple premise that when the consensus dislikes a stock, they sell it, thus decreasing the price. When this becomes a trend, it can cause stocks to be oversold, offering opportunities.

Also, to outperform the market, you have to differentiate from the market by investing differently. Contrarian investing, once again, by definition, is making sure you do that.

The problem with a dependency on contrarian takes is that the consensus is right most of the time. So, contrarian takes can be a very costly endeavor. There’s even an argument to make that it goes against value investing principles to take these bets since many of these investments are not asymmetric bets. They can offer big upside but also come with significant downside, either because of actual price decreases or because of opportunity cost.

Howard Marks has discussed the difficulty of contrarian investments in his memos. Being contrarian isn’t enough. You also need to be right, and that takes a lot of work, patience, and confidence.

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Main Problems:

As mentioned above, one of my main problems is that contrarian bets often offer suboptimal risk/reward ratios. They are a game of opinions.

A very good example is the Chinese market. Investing in it in the past years has definitely been a contrarian take. And it’s an educated one that checks many of Marks’ boxes. But in the end, China is the perfect example of how these bets are a game of opinion. There are good arguments from both sides (Side 1: China is uninvestable; Side 2: China is massively undervalued).

Even if the contrarian bet turns out to be “right.” What does “right” even mean? If, five years from now, people figure out that most of their worries regarding China were wrong, would that make the contrarian bet today right?

The bet would’ve had huge opportunity costs, and the annualized return wouldn’t be that great even if Chinese companies doubled. 

If a company like Alibaba, on the other hand, triples within the next two to three years, then it would be a great investment.

But what scenario is more likely? Don’t get me wrong—I’m invested in Alibaba, so I do believe in the investment opportunity. However, one must accept that this investment is about opinion. There are good arguments on both sides.

This makes it an investment with a high potential upside but a sizeable downside, too—even if it is just the opportunity cost of holding an investment that doesn’t increase for a long time.

Everything I just wrote is mostly true for large-cap investments. Large caps are monitored by dozens of analysts from the biggest financial institutions in the world. Information flows quickly, and thus, markets tend to be rather well-informed and rational.

Rational doesn’t mean that there can’t be outsized performance by a certain stock. It does, however, mean that stocks offering the possibility of high returns also come with more risks.

Asymmetric Investments

I just said that the above points are mostly true for large-cap investments. So, what’s the alternative? Invest in smaller companies.

What is the great thing about smaller companies?

Well, this is not an article bashing contrarian investments. I like the idea of contrarian investing, and I have had good returns on these bets. But if I can find a better risk/reward profile, I’ll take that opportunity.

The great thing about smaller companies is that there is no dependency on contrarianism. You can take contrarian positions, but you don’t need to.

It’s enough to invest in a growing, profitable company that is not yet on the radar of most investors. And these opportunities exist. Those are not a question of opinion (at least a lot less). They don’t need to be in a place of weakness, not even short-term, to be cheap.

They’re cheap because they’re unknown. They’re unknown because the best investors in the game, sooner or later, have too much capital to still invest there. They’re cheap because institutions cannot yet invest in them.

There are systematic benefits to investing in smaller companies.

Of course, they come with different risks. But that's a topic for another day.

These were some rather spontaneous thoughts I had on this topic. Let me know what you think.

Next week, I’ll publish my next stock pitches.

Here’s the latest one:

Have a great day!

Daniel

Today, I want to show you the best company I found in the cannabis market. Two or three showed good execution compared to the vast majority of the sector, but this one was outstanding.

Next week, I‘ll pitch two companies from the educational sector, either in one article or in two separate ones. We‘ll see.

Despite both industries being punished by investors, there are huge differences in their long-term outlooks, or better said, the outlook for their incumbents. While both markets are expected to grow quite significantly in the future, the online education market is much more likely to be disrupted, and current market leaders are already losing share at an increasing pace due to AI applications like ChatGPT.

In the cannabis market, I consider it more likely that some of the established companies will also be the big winners of the future growth in the industry. Up until then, however, there will be many bankruptcies and business failures along the way.

That’s why I focused my research on companies that execute well and focus on fundamentals and cash flows instead of “growth at all costs.” Today’s company did that very well.

But that‘s enough for the intro. Let's get to the pitch! (By the way: The next free-to-read Investment Post will be published on Friday!)

High Tide ( )

Overview:

• Price: US$2,98; CAD 4.12

• Shares Outstanding: 80,68MM

• Market Cap: CAD 332,39MM 

• TTM Revenue: CAD 511,12M

• Interest Bearing Debt: CAD 28MM

• Cash: CAD 35,25MM

• EV/Trailing Revenue: 0.71x

• EV/2024 Adjusted EBITDA: 9.1x

Since I started researching High Tide, its price has increased by over 40%. Intuitively, this is a downer for me. However, as mentioned in my last article, micro and small caps, and especially companies suffering from weak overall industry performance, can be good buys at recent highs.

It prevents you from buying companies that don‘t get anywhere for months or longer, which can lead to high opportunity costs.

High Tide is also a very volatile stock. There‘s a good chance „being late to the party“ quickly turns into a bargain again. Additionally, I estimate the fair value to be closer to $5 with the potential for higher returns in the future, so there’s still room for growth even after the current price increases.

High Tide is one of Canada‘s biggest cannabis stores. It’s profitable and fast-growing, benefiting from good acquisitions, a healthy balance sheet, unprofitable competition, and increasing bankruptcies in the sector, leading to a consolidation of the market and the potential for cheap acquisitions.

As you can see in the overview, HITI trades at low multiples, has enough cash to pay off debt, and is free cash flow positive. These are things the vast majority of competitors cannot claim to be.

In the first nine months of 2024, and most likely also at the end of the year, High Tide will be net income positive for the first time, currently standing at CAD 991,000 in profits. The main reason for the profit is higher revenues combined with lower expenses due to savings in G&A, less SBC, and depreciation and amortization. While profits are low, you‘ll see that they mainly and successfully focused on free cash flows instead of GAAP profitability. Also, Depreciation and Amortization hide the actual profitability.

Another good sign is that both brick-and-mortar and E-commerce businesses have become profitable. Both online and offline businesses are mainly run through the Canna Cabana brand.

Retail:

Since the majority of revenues and profits come from the physical retail business (93%), let’s take a closer look at the stores. Despite the Canadian cannabis industry struggling in 2024 (decline of 1-2% YoY), HITI grew sales by ~6% in Q3 and 6.5% in the nine months ended.

The reason for HITI’s outperformance in the sector is also visible in the store economics. The average store in Alberta, one of the five provinces HITI is active in, generates 2.4x the revenue compared to peers. In Ontario, it’s 3.5x.

On average, it takes only 10 months to pay back the costs of building a new store. One of the many reasons for the good store performance is the focus on good areas for new stores instead of increasing store count for prestige reasons or empire building.

A potential problem to look out for in the future is margins. More on that later. The average 4-wall gross margin is 25%, and the 4-wall EBITDA margin is 12%. So, on a per-store basis, they look fine. If you haven’t heard this term before, “4-wall margin” refers to the margin within one retail store.

So, it’s based only on the operations within one store and does not account for any overhead costs caused by the overall company.

The annualized sales per square foot stand at 1,658 CAD, which is not only great for a cannabis store but puts HITI in the top five of all retail stores nationally.

Brands:

As mentioned, HITI also strategically acquired companies to increase its product variety or automate and accelerate the retail process. Two of the more recently acquired companies are Fastendr and Queen of Bud.

Fastendr is an automation tool that employs retail kiosks to facilitate a better buying experience through browsing, ordering, and pick-up. The technology catalyzes faster transaction times, lowers overhead and labor costs, and provides a seamless end-to-end customer experience.

It’s already installed in 160 stores and is planned to be in every store within the next few weeks.

Queen of Bud is a premium cannabis brand focused on high quality and leaning into the spiritual side of cannabis consumption. It’s one of the white labels HITI plans to build out within its stores. The longer-term goal (3-5 years) is to have 20-25% white-label products. High-quality labels like Queen of Blud are a good opportunity to increase margins.

In recent years, HITI has seen some slight gross margins decrease due to store growth (new stores first need to ramp up before reaching full margin potential), less e-commerce after covid (which has higher margins), and the Canna Cabana membership programs, which drive higher revenues but also decrease margins slightly. Gross margins went from 37% in 2020 to 27% in 2024.

However, this decline seems more drastic than it is since it cannot be extrapolated into the future. The high gross margin of 2020 was due to E-commerce being much larger in Covid times. While this increased margins significantly, revenues only stood at 83MM CAD compared to ~550MM CAD for 2024. Currently, e-commerce is still shrinking and responsible for only 7% of revenues.

Membership Programs:

In 2021, HITI launched the Canna Cabana Discount Club, which offers members discounts between 10 and 25% and special discounts on consumption accessories of up to 80%.

It’s linked to a loyalty program and is growing at an enormous speed, having already reached close to 1.6 million members and still growing at 41% YoY.

In November 2022, Canna Cabana launched the first paid membership program, ELITE. It offers greater discounts, flash sales, exclusive access to branded products, and other perks.

The idea was to benefit from the strength of subscription models, increase the loyalty loop, and create a high-margin business that delivers predictable recurring revenues. ELITE was well received, and due to the high demand, prices were raised from $30 a month to $35.

ELITE reached 57,000 members in September and has shown YoY growth of 203% (despite the price increases).

I‘m relatively confident that more white-label products, paid membership programs, and increasing e-commerce sales will help margin expansion in the future.

Cannabis Industry:

I’m sure most of you are aware of this, but contrary to popular belief, young industries are often capital destroyers even though they keep growing in the long run.

Buffett once used the early beginnings of the car industry as an analogy. Although everybody knew that cars would replace horses, almost no one profitably invested in car companies. Most companies went bankrupt, and most of the first movers were replaced by new entrants (Fun Fact: While not important to young industries, despite the automobile success story, the car industry remains tough for companies and investors until today).

As Buffett said, the safest investment would’ve been to go short on horses. And while there is no obvious short created by the rise of the cannabis industry, it seems like the cannabis industry has been such a capital destroyer in recent years. And I’m sure there will be plenty more opportunities to bet on the wrong horse in the years to come. The companies that will succeed will be the ones executing like High Tide.

Will they turn out on top in the end? I don’t know. Nobody knows that. But they seem to do anything right to get themselves into a strong position. They’re focusing on the fundamentals, on cash flow, instead of fast growth fueled by losses or accounting tricks to look more profitable than they are.

Last year, they reduced the number of new stores built to 11 instead of the usual 30-40 to focus on becoming free cash flow positive. After achieving that, they are now on track to build 20-30 new stores in 2024 while remaining free cash flow positive. In the last four quarters, HITI generated 21.8MM CAD in free cash flow, representing 6% of the Enterprise Value.

What remains very unclear about the industry is how cannabis regulation will evolve in the years ahead. The Canadian market has been one of the most liberal in terms of cannabis. In the US, it depends on the state; in Europe on the country.

While some US states like California or Oregon have fully legalized cannabis for recreational and medical use, others still prohibit the use or possession of cannabis. And even in California, despite the legalization, up to 70% of cannabis sold still comes from the black market due to high taxes and regulatory costs.

In Europe, rules and laws vary greatly. In Spain, there‘s the concept of cannabis social clubs where members are allowed to use cannabis. Private use and cultivation are decriminalized, but cannabis remains technically illegal.

The Netherlands allows the sale of cannabis in licensed coffee shops, which can sell small amounts for personal use. However, cultivation and wholesale supply remain largely unregulated and technically illegal, creating a “gray market” for production. This partial tolerance model results in a relatively unregulated backend, with coffee shops sourcing cannabis from unregulated suppliers.

Countries like Portugal, Luxembourg, and the Czech Republic have decriminalized Cannabis, allowing personal use and growing 4-5 plants per household, but have no legal framework for purchasing or selling cannabis.

The German market is talked about a lot by cannabis companies worldwide since legalization would quickly turn it into the biggest market in Europe, with an expected size of over 4.5 billion USD by 2034.

However, I would be cautious about how much emphasis one puts on this market opportunity. Initially, the current German government, consisting of three parties (the Greens, Social Democrats, and the Liberals), planned to get the Cannabis regulation done quickly after taking over in 2021. Instead, it took years until the first concepts were developed. In 2023, they announced a model similar to Spain's.

Personal possession is allowed up to 25 grams, home cultivation of up to three plants, and Cannabis social clubs to grow and share cannabis. This is supposed to be the first stage of what should become a free commercial market in the long run.

But there are multiple reasons to doubt that this will happen anytime soon.

First, the current government has been struggling internally for the past two years, and it does not seem certain they will continue with their original plans. Next year, there are elections, and it looks like this government will be replaced by the more conservative CDU, which is a loud critic of Cannabis legalization.

Additionally, EU law prohibits the commercialization of recreational cannabis. So, there would need to be a change in EU law or a model that bypasses it. I’m not an expert on EU law or each country’s opinion on cannabis, but judging by the general sentiment around cannabis, I wouldn’t count on any changes in the near future.

Risks:

As always, there are risks involved in this investment. However, I must say that the company-related risks I will list do not concern me a lot. It’s more about the risks involving the industry and the investor’s sentiment and sensitivity to news regarding regulation.

Company Related:

Dilution:

As the chart below shows, HITI has experienced considerable dilution in the last five years, with a slowdown in the last two years. Most of the issued shares were used to fund acquisitions, many of which happened in 2021. Examples include Smoke Cartel, FAB Nutrition, DHC Supply, and NuLeaf Naturals. Besides these acquisitions, High Tide also issued 8 million shares via an At-The-Money offering (30 million are authorized in total), and in late 2023, it restructured CAD 8.9 million of outstanding convertible debenture debt by issuing shares.

The ATM offerings and the debt reduction were smart moves, in my opinion. This year, HITI only issued 1.05 million shares through ATM, and looking at its balance sheet, there is no need for further large issuance. Acquisitions were necessary initially, but dilution through acquisitions should be done carefully going forward. There will be opportunities for smart M&A, but the risk-reward of such acquisitions from a shareholder perspective must be closely monitored.

Revenue Growth:

Revenue growth YoY has only been ~6.5% compared to 37% last year and close to 100% in 2022. However, there are two reasons for that that I consider short-term. First, as mentioned, the Canadian cannabis industry shrunk slightly in 2024. Second, HITI focused on becoming FCF-positive and, therefore, built fewer stores, which led to slower growth.

By increasing the store count again, I’m positive they will increase growth rates again. Without tailwinds from the industry, though, I don’t think we will get close to the 37% last year. I would expect growth rates between 10-15%.

Industry-Related:

Regulation: Studying the sector, I’ve seen many investment theses or forecasts betting on full legalization in the US, Germany, and, longer-term, more European markets.

I do not include any of these hopes in my valuation or thesis for High Tide (HITI’s management isn’t either) or any other cannabis company. The good news constantly gets canceled out by bad ones. In the US, the rescheduling of cannabis from Schedule 1 to Schedule 3 has been discussed for quite some time now. This should bring tax benefits to cannabis companies and open more research opportunities. However, even if this happens, approval by the FDA is still nowhere in sight, which causes sales by cannabis companies to remain unlawful, making it more difficult to get banking services.

The problems in Germany have already been discussed above.

Investor Sentiment: HITI stock and the cannabis sector, in general, are very volatile since investors react very sensitively to news on regulation. At first sight, this can make this sector less attractive to investors. I would argue that this can be a huge benefit.

Having companies like HITI on your watchlist and buying them when the market punishes them for news on the sector is a great way to benefit from low prices without fundamental reasons.

Now, you might argue that bad news for the sector is also affecting the fundamentals of HITI in the long term. And while that’s not wrong, I think HITI’s setup makes it relatively immune. Doing business in Canada, where the regulatory environment is pretty stable.

Legalization can be seen as an additional upside if it should happen, but there’s no immediate need for legalization to make HITI an attractive investment opportunity.

Valuation:

Below, I have listed some of HITI's biggest competitors. As you can see, even after the price increases, HITI remains undervalued relative to the competition. This is most obvious in the EV /Sales and Price to Cash Flow metrics, but the differences in the EBITDA metrics are also larger than they appear here if we take the adjusted EBITDA numbers.

In HITI’s case, adjusted EBITDA for the nine quarters of 2024 came out at 30.1MM CAD, while EBITDA stood at 25.7MM CAD. A difference of 4.4MM CAD.

When the discount to competitors was still larger due to the lower stock price, the discount combined with the strong operating performance could’ve justified an investment already. Although I’m usually not a fan of relative valuation, it can make sense in beaten-down industries since there’s less risk of buying companies that are relatively “cheap” but in an overall overpriced market.

Also, the problem with valuing HITI based on earnings or FCF is that its track record of profitability is still too young, and FCFs, while positive, are very volatile. Thus, our best shot to get an idea of where High Tide should trade without making it too complex is using EV/Adjusted EBITDA. Dividing the 365MM CAD / 40MM CAD gives us 9.1x. Most competitors are closer to 20x or higher.

Assuming an EV/Adj. EBITDA multiple of 15, which would still be considerably below the sector median, HITI could trade at ~USD 4. Looking at the EV/Sales multiples from the table, it could also trade closer to USD 5 or USD 6. However, as always with relative valuation, companies have many differences and cannot be compared 1 to 1. Instead of focusing on price targets, these calculations should show that HITI is valued below its peers despite being a superior company.

The table below shows the operational performance based on the longer-term estimates HITI provided in earnings calls and presentations. I broke them down into what they would mean for the business on an annual basis if I distributed the growth equally over the years. They do not include any expansion into the US, Germany, or other jurisdictions. Most of the growth will come from new stores in Ontario.

I think these goals are very achievable. Based on these estimates, I will build a valuation model that breaks down the financial statements in more detail to see what I consider realistic estimates for profits and, more importantly, cash flows in the years ahead. This should give a clearer picture of HITI's fair value.

Investment Decision:

I said that it can be advantageous to buy micro or small caps even after they appreciate a lot. However, the value investor in me doesn’t yet feel comfortable buying this company after seeing it run up 40% in a matter of weeks and over 100% in the last twelve months. Especially since the industry has a history of volatility (and boom and busts), which might eventually give me a better entry price.

I might be a great example of how the anchoring bias works right now. I started researching the sector and came across HITI when it was slightly over 2 USD. I’ve probably anchored this price as the price at which this investment offers the margin of safety I want.

I justify this thought process by arguing that HITI is not a micro-cap, where buying at recent highs is even more helpful since the discovery process is in the very early stages. Also, with a market cap of 336,26M CAD (241,94 USD) and the status of one of the largest cannabis retailers in Canada, HITI is not really under the radar (although it kind of is since it’s mostly traded in the US, but less known there due to its operational focus on Canada and the big number of US cannabis companies).

The stock price depreciation was largely due to the fact that it has now become a profitable company. The strong Q3 results fuelled this rally. This also means that a loss-making quarter or bad news concerning the cannabis industry (regulatory problems, reclassifications, and legalizations taking longer than expected, etc.) could cause the stock to depreciate in the short term.

Because of this, HITI is going on my watchlist with price alarms set at 2,50 USD and lower. If those prices are reached and the fundamentals remain strong, as I expect, I will start building a position.

That’s it for today! As mentioned, you’ll get another pitch next week and an article on general investing wisdom in the meantime!

Cheers!

Daniel

Because of that, I received questions about why I didn’t take indices that better resemble my strategy or portfolio. If I had taken small-cap indices, I wouldn’t have had similar returns to the market but beaten it by a wide margin since they performed much worse than the S&P, MSCI World, or my portfolio.

But I don’t think that’s how you should approach benchmarking. I know that many funds do this. They choose benchmarks that supposedly(!) resemble their portfolios and strategies instead of the major indices.

The S&P 500 and why many don’t use it as a Benchmark

This has benefited them in recent years since indices like the S&P 500 and NASDAQ are among the strongest performers, and almost every other index is far behind. This is mostly because the top 5 to 10 holdings drive the majority of returns.

This chart compares the Magnificent 7 to the rest of the S&P 500. As you can see, the difference is huge year-to-date—about 10%. This is not unique to 2024; it has been happening for years.

Because of the Magnificent 7's remarkable performance over recent years, and therefore the S&P 500, many fund managers prefer to use different benchmarks and argue that they have a different strategy that cannot be compared to the S&P 500 (or the Magnificent 7).

I don’t think you can do this in the long term.

Get Access to my Research

My Problem with using different Benchmarks

What matters most is not your strategy but what alternatives you have to invest in. You should base your investing strategy on what you think will have the best returns going forward. If you’re right, you should outperform the broad market (because your theme or niche outperforms). And if you’re good at executing, you should then also outperform the indices in your niche (because you pick the biggest winners).

If you (in the long term!) only outperform the indices in your niche but not the broader market, then you have simply chosen the wrong strategy.

You always have the option to just invest in the broader market. For US citizens, that’s probably the S&P 500. For people outside the US, this can be your national stock market index, or you choose an index covering the entire world.

And by that logic, your alternative is always one of the major indices. Thus, it should ultimately also be your benchmark. This might be uncomfortable when the index performs over 20%, but that’s the current reality.

That’s why I said I’m happy with the low correlation my portfolio has to the S&P 500 or the MSCI World. If I can repeat my performance in recent years without tracking the big indices, I can probably also do it when the indices stop performing at those levels. And sooner or later, that will happen.

Absolute Returns and Overcoming Recency Bias

I posted a one-page summary of Seth Klarman’s book Margin of Safety yesterday. Klarman is an advocate of absolute performance. So, instead of using a benchmark, he focuses on the absolute returns of his portfolio.

He does so to avoid falling into the trap of short-term thinking to outperform the index every quarter and the consequence of more or less just tracking its positions (like so many funds do).

The high correlation with the index will make it virtually impossible to outperform it meaningfully or at all. For investors who joined the market after the financial crisis in 2008, this might sound like a fund manager's excuse to never admit he underperforms.

However, all of us who joined the markets in that period are recency-biased into thinking the stock market always performs at the astronomical levels we’ve seen in recent years. That’s not the case.

There have always been lost decades or years of low returns in the stock market's history. In those times, focusing on absolute returns makes sense. If the market returns 3%, you can outperform it with 4%, but that’s still not a good absolute return.

Conclusion

So, there is an argument for focusing on absolute returns, and in some (rare) cases, there might also be an argument for benchmarking against niche indices. However, in the vast majority of cases, I believe that you should use the major indices as benchmarks. Not necessarily on an annual basis, to avoid short-sightedness, but definitely over 3-5 year periods.

In recent months, I changed my strategy, and I’m now a lot more focused on micro caps. This takes more time to research because you really need to find the right ones (thus, fewer but higher quality research articles right now. I don’t want to spam mid-quality pitches just for the sake of it.)

But they also offer much higher returns. So, going forward, I raise my hurdle rate from 15% to 25% annual returns. With this goal in mind, comparisons to the market should become less important anyway since large caps can’t compete with these returns (at least over longer time horizons ;) ).

Yet, to conclude, I believe that every investor should use a benchmark that’s the realistic alternative for him to invest in if he wouldn’t invest actively himself. These should be the indices offering the best returns while being reasonably diversified. That can be the S&P 500 (although diversification is arguable) or an index investing in stocks globally.

That’s it for today! I hope you learned something new and/or at least found it interesting.

Best

Daniel

Join the Community

Of course, whenever there are earnings updates, I continue to update each stock individually and if you have any questions, the Discord Community is the perfect way to reach out to me personally at any time.

Since my last portfolio discussion was roughly six months ago, it’s time again. I’ll also use this article to briefly discuss my current holdings and my main thesis about each of them.

I currently hold five positions (plus a small one to keep an eye on the stock):

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