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Cloudy with a Chance of Profit

Published 2020/08/03, 10:09
Updated 2023/07/09, 12:32

Market Scorecard

The markets on Friday were rather choppy. Locally, the All-Share started in the green but then finished in the red. For US markets, they started in the green, then dropped quickly into the red, but were green by the close. The US market was assisted by Apple surging 10.5% after their earnings on Thursday evening. The increase in share price puts Apple back at the top spot for the most valuable company on the planet with a market cap of $1.84 trillion. Saudi Aramco is second with a value of $1.74 trillion - is this value accurate though given that only 1.5% of the company is listed? We will have all the Apple details tomorrow as we cover Google and Amazon today.

On Friday the JSE All-share closed down 0.22%, the S&P 500 closed up 0.77%, and the Nasdaq closed up 1.49%.

Byron's Beats

On Thursday last week Alphabet (Google) released second quarter results. Revenues came in at $38.3bn, which was 2% lower than the second quarter of 2019 but 3% higher than expectations. Earnings per share smashed expectations by 28%, coming in at $10.13 a share.

As expected the advertising business took a knock. Businesses have less cash to spend on marketing and people click on fewer ads when they have less money to spend. Advertising still makes up nearly 80% of this business. Within the advertising business Youtube saw decent growth. Youtube now makes up nearly 13% of ad revenues.

What was very encouraging was the solid growth in Google cloud (sales up 42%) and Google Other, which includes Android and the app store. That was up 25% in sales.

In this environment Alphabet can be considered a value play. Unbelievable for a "FANG" stock I know. It trades on 20 times forward earnings and has over 120bn in cash. That is cheeper than the market average. They don't pay a dividend but are currently running a massive share buyback program. An extra $28bn was approved for buybacks this quarter.

I compared the share price of Google to the Nasdaq index and the performance is very similar, see graph below. This means that Google shares have not done anything special for a while.

We see this as a really good buying opportunity. We have seen Apple and Amazon go through big patches of strong outperformance as their share prices rerate. Google is due a period of strong outperformance soon. Load up now.

Bright's Banter

Amazon reported a very good set of quarterly numbers, easily beating the streets expectations. This was thanks to more people shopping online and more businesses migrating to the cloud. The Seattle-based e-commerce giant has had to invest more money in its people and its supply chain to ensure worker safety as well as to alleviate supply chain pressures due to a big surge in demand.

Amazon reported revenues of $88.91 billion, up 40% which led to profits doubling to $5.2 billion. Online grocery sales tripled year-on-year as people avoided physical stores during the pandemic. Amazon also said that they're seeing cloud migration plans accelerate, which led to a backlog for cloud services accelerating from 58% to 65%. AWS printed $10.81 billion in revenues, up 29% year-on-year.

Amazon's CFO Brian Olsavsky said the following in relation to Amazons efforts in lowering cloud costs even further, especially for businesses like travel, entertainment and hospitality which have been decimated by this pandemic: "We think that's the right thing to do not only for their success, and so they can come out of this in better shape, but also for the long-term health of our relationship with them as an AWS provider,"

The e-commerce giant said that it spent $4 billion between April and June to stabilise its supply chain and improve worker pay and safety in these days of physical distancing. They will spend a further $2 billion on Covid-19 related costs in the current quarter as worker safety continues to take preference.

Amazon continues to hire in order to keep up with the surge in demand for online orders - people are shopping more often with larger baskets. They now employ over a million workers, making it the second largest employer in the US, coming second only to Walmart, which employs over 1.5 million people.

The good news is that due to this big surge in demand, Amazon's non-US business which usually loses money, made $345 million in profits. Amazon continues to be the best-in-class performer up over 65% year-to-date, which is why we still strongly believe that it should be a core holding of every offshore portfolio. I hope they follow Apple's footsteps and do a share-split already!

One Thing, From Paul

2020 certainly has been a stand-out year. We will all remember this one, that's for sure. Still, time marches on, now it's August and we are one day closer to the end of the pandemic.

The economic slump caused by Covid-19 lockdowns is unprecedented, and are causing multiple knock-on effects. For example, the Spanish banking group Santander just announced its first loss in their 163-year history. That's right, its first bad year since 1857.

Massive asset write-downs were taken across the globe. Provisions for bad debts were hiked in retail operations in Europe and the UK, and at a sub-prime lending operation in the US. Weaker currencies in Brazil and Mexico lowered the contributions from those regions.

Santander was founded in the small northern port-town of that name in the province of Cantabria. It is now headquartered in Madrid and is about the 15th largest banking institution in the world. It is listed on the Bolsa de Madrid and the NYSE.

Santander was built by a dazzling string of acquisitions around the world, under the leadership of Emilio Botin. He ran the bank from 1986 until his death in 2014, when he was succeeded by his daughter, current chair of the board, Ana Botin.

Banks are central to the global economy, but their returns are tied to economic cycles, and they are prone to deep slides in value in times of crisis. Santander shares are down by 45% this year.

Michael's Musings

Reading one of my textbooks recently, it was talking about how the market arrives at a share price for a particular company. We often talk about share price values in the newsletter, but it is worth talking about it again because it is such a vital part of staying sane when invested in equities. At its simplest, share prices are set based on future expectations.

First off, the long term average return of the market is between 5%-10%, a rough rule of thumb is a return of 5% after taking inflation into account. If this is the long term average return of equity returns, then this is what investors should expect when investing. To keep things consistent, we will assume that the overall return expected by all market participants is 10% - we will call this the market return. Most people expect much more, but that is another topic entirely.

The textbook made a good point, something that isn't pointed out often enough. If the market expects a company to grow its profits by 20% over the next few years, and it matches those expectations, then its share price will go up by the market return of 10% a year. If the company only grows its profits by 15%, then its share price will struggle. So even though the company was growing profits, because it missed expectation, its share price will reflect the market's disappointment.

Of course, if the company grows profits by more than the expected 20%, then it will see its share price go up by more than the market return of 10%. What tends to happen is that quality companies, consistently grow profits at a faster rate than expectations. As a result their share prices continually outperform.

The lesson for long-term investors is to buy quality. Companies that have strong brands, a good business model and operate in a growing sector. You normally have to pay up for this quality, but it is worth it.

Signing Off

Many small-cap companies are reporting in the US today, but none that are on the Vestact radar. Ferrari (NYSE:RACE) is one of the mid-cap companies reporting; it will be interesting to see how well high-end car sales performed during this period of uncertainty. The Rand has slipped a bit in the last few days, now trading around the $/R 17.00 mark. Gold is 1% away from crossing $2 000 an ounce for the first time. We will leave the shiny metal to others and rather be invested in real companies.

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