Thoughts about Numbers VS Narrative

Thoughts about Numbers VS Narrative

Every investor's investing framework is different based on his personality and experiences. Deep value investing and factor investing is easily replicated by simple stock screeners and Vanguard / MSCI sector funds, to the point that I believe most mainstream value opportunities are increasingly arbitraged away by machines and algorithms. Growth investing based on deep investigation on a company's special qualities is popularized by Philip Fisher's 15 points. A blend of both numbers and narrative is preferred by quant-like investors like Aswoth Damodaran. The Good Investors is another blog by Singapore based investors which I regularly follow, whom used a blend of Motley's fools narrative approach, sufficient quantitative rigor and putting less weight on traditional valuation metrics to pick highly volatile companies that is likely to grow to its current valuations.

The Good Investors

1. Revenues that are small in relation to a large and/or growing market, or revenues that are large in a fast-growing market.
2. A strong balance sheet with minimal or a reasonable amount of debt.
3. A management team with integrity, capability, and an innovative mindset.
4. Revenue streams that are recurring in nature, either through contracts or customer-behaviour.
5. A proven ability to grow.
6. A high likelihood of generating a strong and growing stream of free cash flow in the future.

Personally, I use a checklist approach approach to incorporate qualitative and quantitative factors based on my understanding of the fundamentals of the business, to determine the appropriate cash flows, capex, growth and risk of the company, to estimate an intrinsic value of a company. This checklist also incorporates the perimeters of my circle of competence to determine whether I have superior knowledge in certain areas, or I am simply being brainwashed / caught up with market hype.

My inclination is tilted towards achieving a margin of safety / capitalizing on price shocks on the companies share price that has no deterioration in long term business fundamentals.  As most large cap and liquid stocks are over-analyzed by institutionals (especially in the US market), true mispricing opportunities are very lumpy and few throughout the year and I spend most of my spare time reading thinking and doing nothing. The recent market correction is a god-send as I believe that the stock market is relatively weighing the risks and rewards fairly (incorporating Value bears, gold mongers, bitcoin crypt-lords, robin hood day traders and Tesla bulls) and I seek only to invest in companies that I believe I have an superior edge in assessing.

Portfolio Decisions for the month of July
SGX

I bought a second tranche high conviction position of the SGX on 16 July 2020 at the price of SGD 8.20. My personal valuation of the SGX prospects greatly differs from the established valuations from the broker analysts. It is tremendously difficult to be contrarian considering the superior market knowledge and models the analysts have. The only fact dis-confirming the official valuations from the brokers rises from the transaction volume and value of the derivatives contracts, as well as the equity buy/sell volumes in the SGX, and my assessment on the future growth prospects of the derivatives market.

With this buy, SGX incidentally became my second largest position in my portfolio. I am exceptionally wary of overpaying for growth and under-performing in the short term, but I have to live with this decision as an active investor.

Microsoft

I bought an initiating tranche high conviction position of MSFT on 31 July at the price of USD 202.00. Conventional wisdom suggests Microsoft is probably considered a boring  <Uncle stock> which is probably too mammoth in size to generate any substantial growth moving forward, and the dividend payout will probably deter its growth plans compared to hipper FANG stocks. A critical look at the recent annual numbers suggests otherwise. A deep dive into the recent developments forced me to reevaluate the possibility of MSFT as a mammoth but still reasonably priced large cap growth stock.

Pros
Established products and distribution network

Microsoft second largest market leader in the US cloud market, which has a large addressable market and continually expanding. It has established business relationships with various business entities, schools and private consumers due to its dominance in the enterprise business market, greatly reducing customer acquisition costs.  It is able to expand its new cloud and machine learning products sales through its existing superior distribution network. I also like the strategic assets of MSFT Office suite, LinkedIn and Github which are core utilities in an rapidly restructuring economy.

Will to innovate and not follow the path of IBM
The elephant in the room is that MSFT as a legacy company may be too big and too mammoth to change its old ways. Ex CEO Steve Balmer is noticeably a joke with the Nokia / Windows smartphone failures in the the technology space, but what went unsaid is that he managed to orchestrate the growth in enterprise business. New CEO Satya Nadella is pivoting on a shift towards <Hitting refresh> on its corporate culture and realigning its focus to cooperate with other software giants /rivals to cement its market share.

Pent up Demand for Microsoft new product offerings

My varied readings on MSFT developments revealed a significant buildup of its contract book, whereby many established companies are increasing uptake on its cloud (azure) and machine learning product offerings. Even if the economy is not doing well and business volumes are dropping, I believe companies will take the opportunity to relearn new technologies by established vendors and restructure to streamline costs and improve operational processes. There is an noticeable fundamental shift throughout educational providers as they start to provide upgrading courses with established software providers to prepare future employees for future skills and technologies.

Key Risk
Strategic execution risk
MSFT is in the midst of restructuring its lumpy contractual cash flows from software licensing to a SAAS like cash flow, which is dangerous for most companies as it invites the possibility of consumers to quit MSFT once a superior / cheaper product is available. However, the stickiness of the Microsoft OS and office suite, and the ability of MSFT to bundle its new offerings with legacy products more or less guarantees the stability of cash flows and greatly reducing consumer churn.

Legislative risk
Facebook, Amazon, Alphabet, Apple has been summoned to face scrutiny in its business practices following its incredible market dominance and performance, which may invite potential corrections in the share price despite stellar financial performance. Microsoft has noticeably outmaneuvered from the spotlight and potentially capture market share if there are dire penalties imposed on those companies to cap their growth and dominance.

Overpaying risk
It is a fact that Microsoft is overpriced by traditional valuation metrics, no matter how I look at it. Cross referencing with other online valuation (which adopt a strictly quantitative approach) suggests it might be overvalued for about 10-20% considering its legacy numbers, so I am overpaying without a margin of safety. However, the aforementioned qualitative factors and brand value (Narrative) is so much in conflict with the numbers, that I believe the legacy numbers based valuation is insufficient to assess its intrinsic value. A lot of things must continue to go right with Microsoft despite its general strong track record, and I hope it will grow to its valuation and hopefully surpass it.