I read an article on the Fool.com site titled How to beat the S&P 500 in 2023. A link to the original article can be found by clicking here. The author hopes that 2023 will be a better year for the stock market than 2022, as do we. Readers can increase their chances of beating the S&P 500 by following the author’s playbook, but they cannot promise anything. Ok, So what is the playbook?
Stock market crashes breed opportunities
Well, since tech companies, growth stocks, and other beaten-down assets had a rough ride, they will eventually start heading in the right direction. But a distinction has to be made between a broken company and a broken share price of an otherwise good business. That’s a good point. All stocks are exposed to the market factor. Some more than others. And, of course, we can all think of examples of stocks that have dropped like stones because, well, everyone is selling everything.
Two companies, Meta Platforms–formally known as Facebook–and Skillz, are given as examples. Both have seen their share prices decline over the last year by 67% in the case of the company formally known as Facebook and 87% for Skillz. Both have underperformed the S&P 500, which fell by 17%. Given declines like that, the author argues, it might be tempting to think that both are on the verge of failure.
But as the Motley Fool author points out, Skillz is burning as much free cash flow as it brings in on the top line. Well, that’s not strictly true, but sure, the company does have a negative free cash flow and is loss-making. On the other hand, Meta is bringing in billions in revenue and free cash flow. Stocks are not equal, and the point, although not made explicitly, can only be reasonably interpreted as Meta is a bargain, but Skillz is not.
But is that a fair comparison? Skillz is, in fact, growing its revenue quickly. It might not match Meta in absolute terms, but to ignore it whilst making reference to Meta’s revenue size seems unfair. And the two companies are at completely different stages in their lifecycles. I would expect a smaller, younger stock to have a higher beta than an older, mature one. Thus, I would expect the younger stock to fall further in a market sell-off. So, is it a fair comparison? I don’t think so. Relative valuations require comparisons between similar companies, I think the selection is flawed.
Overall the point made is sound. Market crashes bring opportunities. Nearly all stocks will get dragged down in a bear market, crash or correction, pull back or whatever it is. But running a mile from all of them is foolish. There is, of course, a distinction to be made between a broken stock price and a broken company, as the author says. And the other bits of the playbook, like not betting everything on a single company and diversifying, having a long-term approach to investing, and timing markets being difficult or impossible, so buying steadily over time, well, whilst it cannot promise to beat a market, as the author states, I cannot argue with that advice.
One investor might see things one way. Another might see things very differently. What’s to say that it is Meta and not Skillz that is the broken company? Let’s see if we cannot take another view on these two companies.
Tale of the ticker tape
I don’t know much about Skillz. But a trip to the company’s website informs me it is “The Platform For Competitive Mobile Games”. It is, and I quote, “…the leading mobile games platform that brings out the best in everyone through fun, meaningful competition”. There is more, “The platform helps developers build multi-million (sure) franchises by enabling social competition in their games.”. Ok, so I am getting a feel for what the company does. Moving on, the platform “Hosts billions of casual eSports tournaments for millions of mobile players worldwide, distributes millions of prizes each month”.
There are many titillating terms: platform, eSports, mobile, and developers. Skillz is also headquartered in San Francisco, that’s near Silicon Valley, don’t you know, and the company has appeared on lists of the most innovative, fastest-growing, next billion-dollar start-up disruptor companies. Add in substantial top-line growth, and promise that profitability is coming, but acknowledge that the risks are high but so are the rewards, and that’s a hell of a story for Skillz.
On the other hand, we have Meta. Since its IPO in 2012, it has grown at a clip and hit a market cap of one trillion dollars in 2021. It has more active monthly users across its platforms than any other social media company in the world by a massive margin. But, it is losing control of its primary source of revenue: advertising. Apple announced significant changes to its privacy policy, and there is nothing to stop other smartphone makers from following suit. Users have to opt into data sharing when apps like Facebook, Instagram, and WhatsApp are downloaded from app stores. If they don’t, Meta will lose a chunk of its ability to sell targeted ads. Ads will be worth less to the company over time. Users are flocking to alternative, non-meta-owned sites.
Meta’s leader plan to avoid this doom is to spend billions of dollars setting himself up as the lord of a virtual world that nobody is sure they want to live in and turning the companies cash flow negative as he builds his kingdom of wall-to-wall virtual billboards that may never see illumination.
Marketing stories
But anyway, let me get to the point of this article: stories matter. We are called The Storied Investor. Storied can mean recorded and celebrated in history or in a story, or fabled. That speaks to a ridiculous sense of self-aggrandisement that I must apologise for, but it was meant to be tongue-in-cheek. But being storied also means having stories. Investors must have stories about the companies they invest in, as stories matter in investing.
Companies, and in particular their founders, tell tales that entice investors and help drive the valuations, and their net worth, to epic proportions. Companies that cannot do that tend to fall by the wayside. They won’t fail necessarily, but their stock prices might not get the same kind of pop they would with a real orator at the helm.
Forecasting a company’s future needs stories. Revenue will grow at 6% for the next five years. Ok, but why? Why 6%? What is the reason, the story, behind that number? Margins will increase by 5%. Again, why? Why will this happen? An investor might read two analysts arguing over EPS growth. One reckons 5.5 whatever’s per share, the other 4.5.
Every number in investing has to have a story behind why it is being assumed. Without hearing the story behind it, there is no way to choose which number or forecast to believe. The numbers are nothing on their own. Is it more people turning to mobile for internet browsing driving the change, or is it because Stranger Things has sparked an interest in tabletop role-playing games or have exchange rates worked in the company’s favour without it having to lift a finger? It is the story that matters.
The stories I presented about Meta and Skillz (the latter was more of a resume and delivered with appropriate scoff) were deliberately polarising. But they could still form the backbone of an investment thesis. Only time will tell if they turn out to be true.
DISCLAIMER: James J. McCombie does not own shares in Apple, Meta Platforms, or Skillz. The Storied Investor has no beneficial ownership position in any of the shares mentioned
The Storied Investor 