The pullback culminated in a 35% slump on 20th April, a day after Netflix forecast a decline of 2 million subscribers in the three months through June and said it lost 200,000 customers in the first quarter, the first drop in a decade (notably, the only region where it added subscribers was Asia).
Also on 20th April, Pershing Square Capital Management announced it sold its stake in the company, three months after disclosing it to investors, for a reported $400 million loss.
“We require a high degree of predictability in the businesses in which we invest due to the highly concentrated nature of our portfolio,” Pershing Square Founder and Chief Executive Officer Bill Ackman said in a release. “The dispersion of outcomes [for Netflix] has widened to a sufficiently large extent that it is challenging for the company to meet our requirements for a core holding.”
“We require a high degree of predictability” doesn’t seem to gel with allocating almost 6% of assets to a company that you acknowledge has a wider range of possible future outcomes. Netflix’s growth has been curtailed by the launch of streaming services by traditional linear TV providers, along with megacaps such as Apple, Alphabet, Amazon, and Disney.
This is not a criticism of any one style of investing, as every investor has their own risk analysis and portfolio management parameters. At NZS Capital, ours recognises and accepts the unpredictability of the world, so that we strive to eliminate any reliance on hoping that a series of narrow predictions turn out to be accurate.
Not making predictions can be an uncomfortable behaviour for many investors, but it is increasingly necessary as the digital transformation of the economy causes the pace of change to accelerate which, in turn, creates an even more unpredictable world.
Instead of trying to shoehorn a set of predictions into a particular world view, we believe investors should focus on finding companies that stand to see lasting benefit from the transition to digital from analogue. As such, the winning traits for long-term investments are adaptability and maximizing non-zero-sum outcomes, where all parties benefit from taking part in a transaction because the value creation is so great that no one wants to find other providers.
If a security’s valuation implies a need to be correct about a few assumptions for growth to drive stock performance over time, a larger proportion of portfolio assets can be allocated to it. Equally, the inverse is true — if the range of possible outcomes is wide and expanding, making for less certainty about future growth, the position size should be smaller.
Stress-testing assumptions in this way leads to a portfolio built on a core of resilient companies, complemented by a longer tail of smaller optionality positions in earlier-stage businesses that show the potential for significant asymmetric upside versus their downside risk.
An outsize allocation to an optional company whose range of potential outcomes has widened is a bet on a narrow prediction about the future. In addition to raising overall portfolio risk, this ties up resources that might be better allocated to other optionality positions with more appealing asymmetric characteristics.
Disciplined assessment of potential future outcomes is especially important during times of upheaval. The market has a particularly hard time finding equilibrium in times of heightened uncertainty, which today is principally based on rising concern about global conflict, supply chain snarls, and the probability of significant interest rate hikes aimed at taming inflation.
This combination of concerns has led investors to buy into the narrative that companies need to be currently profitable to be good long-term growth investments.
According to consensus analyst estimates, on 28th April Salesforce traded at a 5.6 multiple of its enterprise value to next 12 months sales, while Oracle traded at 5.8 times on the same measure. Yet consensus topline growth for the next respective fiscal year is in the high-teens for Salesforce and is low single-digit for Oracle, with Salesforce growing approximately three to four times faster than Oracle. While Oracle is more profitable today, there are reasons to believe both companies would have roughly similar margin structures at similar growth rates in the future.
Investors seem to have forgotten – hopefully temporarily – that companies investing in their own future growth, and in the overall size of the ecosystem in which they operate, tend to create more value over time.
Key characteristics of the current selloff are that investors are lumping all growth stocks together, while assuming long-term inflation and structurally higher rates. That’s one possible outcome. But a broader prediction is that technology investment cycles are likely to speed up on the back of rising innovation, accelerating our adoption of new technologies, which may drive down rates and inflation, since innovation has always been a powerful deflationary engine of growth.
We can’t say with any degree of certainty which of these possibilities will come to pass. The only thing we know for sure is that we don’t know what the future will bring, so rather than spending time making predictions that more than likely will turn out to be wrong, why not focus on seeking out companies that are creating and benefiting from that future – whatever it may turn out to be?
Brad Slingerlend is an Investor at NZS Capital, which he co-founded with Brinton Johns in 2019. NZS Capital has a strategic partnership with Jupiter Asset Management.
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A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.