Dear Investors,
We hope you and your families are doing well.
The third quarter continued the positive trend with year-to-date performance of approximately +19-25% (net) across your portfolios versus the Russell 2000 Growth returning +13% year-to-date. Please see disclosures for the historical performance data. As many of the stocks in your portfolio have gains of 50-350%, we continue to monitor the position sizes of each company through thoughtful trimming when we believe stock weightings get too large and selling out completely when internal price targets are achieved. Towards the end of the year, we are cognizant of any taxes that may be incurred on selling stocks for gains, so please contact us if you have any personal tax planning needs. While we have had a strong performance so far, we hope to have more positive updates as we enter the holiday season.
Approaching a 6 Year Performance History
This coming December marks the 6th anniversary of our separately managed accounts at GROW. As we reflect on the journey, it’s evident that our stock picking strategy can work in multiple stock market environments. GROW’s performance history can be best understood by considering it in three chapters. In our first chapter, we generated a 24% net annual compounded return for the first three years of our history (Jan 2019 – Dec 2021). In Chapter two, which lasted about one year, we incurred losses on investments as the market digested higher inflation, interest rates and recession fears. At the end of 2022, we published two articles that highlighted our conviction in our two largest holdings: ZETA & APEN. In Chapter three, the portfolios had a strong rebound of +44% in just 11 months as our core ZETA & MAMA holdings posted strong recoveries.
“In the middle of every difficulty lies opportunity” – Albert Einstein
Growth of $1,000,000
Market Summary
During times when the market stages a large and rapid rally, some investors worry that the market has moved “too far, too fast.” But more often than not, rapid and large market rallies are followed by strong subsequent market performance. The market rally this time has been powered by the economic dynamics we described last quarter. Most notably, inflation and higher interest rate worries have slowly faded. In 2022, we experienced a market selloff of a magnitude typically seen in a recession, and likewise we are now seeing the type of recovery that often occurs just after a recession. In September, the Federal Reserve began cutting interest rates with a 50-basis-point reduction. We are optimistic the Fed’s rate cutting trajectory will continue throughout the remainder of 2024 and into 2025. As fiscal tightness eases, we hope a better environment will ultimately lead to business expansion.
As mentioned in previous quarters, we continue to hold oil and natural gas stocks as hedges against the persistent inflationary environment and geopolitical turmoil that we find ourselves in. While oil and gas stocks are not the typical growth stocks we tend to look for, we feel that their defensive and contrarian characteristics make them well suited for this uncertain macro environment. Many of them also pay dividends, providing a source of income in addition to capital appreciation. During the third quarter, one of the top performers was Argan Inc. (AGX) which builds natural gas powerplants. Argan is an indirect AI beneficiary which we describe below in more detail.
For multiple quarters now, we have cited the valuation differences of the “Magnificent 7” stocks compared to the rest of the market (shown above). These seven companies (weight) in the S&P 500 are Apple (7.1%), Microsoft (6.5%), Nvidia (6.0%), Amazon (3.6%), Meta (2.6%), Google (2.0%), and Tesla (1.5%). Today we are in the relatively unique situation of having these 7 companies that make up ~30% of the entire S&P 500. Investors flocked to safety in the “Magnificent 7” companies as they were looking for high quality balance sheets and earnings to hide in amidst an uncertain economic environment in 2022. While this strategy has proven effective, we don't believe that those stocks offer good value relative to their growth rates going forward. Instead, we are choosing to “fish” in the small and mid-cap “ponds” where the valuations are most attractive and below historical averages. While small and mid-cap stocks have participated in the overall market rally, we feel that relative to large, there is still room for them to outperform given the valuation differences. We continue to look for new ideas with superior products and services, providing long runways for growth.
Portfolio Review
Zeta Global Holdings Corp. (ZETA) which we identified in early 2022, has been a top performer up over 255% year to date. We trimmed the Zeta position earlier this year as it reached an overly larger portion of investor portfolios. We continue to hold Zeta as a large weighting as we believe they can continue to take market share in the advertising industry.
Zeta is a marketing technology software company which benefits from multiple market tailwinds in the advertising industry. Zeta’s software platform combined with artificial intelligence helps companies' market more efficiently by targeting ads based on specific demographics. The Zeta marketing platform helps customers deliver advertisements through all channels such as email, social media, web, chat, connected TV and video. Zeta is unique in that their platform doesn’t use cookies. This reduces risk from a regulatory and customer standpoint as they are not impacted by these issues. Consequently, they can take market share from competitors like Adobe, Salesforce, and Oracle who have all made legacy acquisitions to enter the space (valuations of 8-20x EV/Revenues). Oracle announced they would be exiting the advertising business on their Q4 2024 earnings call, creating an incremental revenue opportunity for Zeta. Despite broader softness in software spending, Zeta remains unaffected, citing a healthy demand environment.
The company was founded by former Apple CEO, John Scully, and the management team has a strong track record of performance (the company has beat their revenue guidance for 11 consecutive quarters since their IPO in 2021). As marketing budgets tighten, Zeta is well positioned to take share and potentially benefit from the weakening macro environment.
In early September, the company increased their third quarter 2024 guidance to at least $255 million in revenue, representing year over year growth of at least 35%. This accelerated from Q2 growth of 33% and Q1 growth of 24%. We went into detail on the factors influencing their growth in our previous two quarterly letters, and since then the thesis has begun to play out. Since then, the valuation gap between Zeta and their competitors is beginning to close. Zeta competes with Braze Inc. (5x EV/Revenues) and Klaviyo Inc. (9.6x EV/Revenues) who both have similar revenue growth rates yet are far less profitable than Zeta (7.1x EV/Revenues). We believe Zeta can ultimately trade at a premium valuation to both peers.
Argan Inc. (AGX) operates in the industrial construction industry building natural gas powerplants. The retirement of coal-fired power plants is driving a multi-year cycle of new natural gas fired power plant construction. Tightening environmental regulation, favorable economics and the rise of artificial intelligence (AI) have propelled Argan stock to all-time highs. Argan builds these powerplants for utility companies like Vistra and Duke Energy. There are shortages of power across the country where companies like Microsoft and Meta are building new AI data centers. These data centers consume extreme amounts of power which the current grid capacity is not suited for. We estimate the company is on a path to reach $1 billion in revenue and $100 million in EBITDA as this buildout happens. The company has a current project backlog of $800 million with visibility of growth to $2 billion. Argan holds $430 million in cash, no debt and is highly profitable. Additionally, they recently increased their quarterly dividend to $0.375 for an annual dividend yield of 1.5%. We continue to hold Argan in investor portfolios.
Outlook
We continue to see tremendous investment opportunities in the market. In addition, we believe that the current environment provides an opportunity for stock selection and active management versus passively investing in indexes that are heavily weighted towards the “Magnificent 7.” By continuously screening for companies with new products and services, large market opportunities and high revenue growth with strong margins, we believe your portfolios are well positioned. While we are cautiously monitoring macroeconomic events, our time is best spent looking for new ideas and re-evaluating your portfolios despite the noise. While the companies in our portfolios started the year well, we believe they continue to have upside potential throughout the remainder of 2024.
In conclusion, we thank you for your continued trust and support. We encourage any questions or comments you may have. As always, we are available for portfolio reviews anytime. Please contact us if you are interested in learning more about the companies you own.
Best regards,
Comentarios