Why I Own What I Own

Plus: My portfolio performance

Hey folks,

Over the last year, a serendipitous market decline allowed me to buy high-quality names at bargain prices, driving outsized returns that will rarely repeat. Though most of it is luck, I think a minor portion of this performance stems from my following a buy and sell discipline, which I outlined here.

I can summarize it in three points:

1. Trim winners slowly.

2. Wait patiently for your thesis to play.

3. Cut losers or buy more if your thesis is intact.

Most stocks I bought since March were winners. Realizing gains along the way helped me hold them for even more significant gains. That’s the case with Tesla, my biggest winner, but also with Revolve, Duluth, RCI Hospitality, and Twitter.

Some stocks haven’t moved. I’m talking about Facebook, Research Solutions, and MSOS. In those instances, I’m waiting for my thesis to play out. In other cases (EWZ and AutoCanada), I exited the position entirely because the upside was limited, and the thesis had been exhausted.

What Do I Own, and Why?

First, let me show you my current allocation.

This is an excellent time to revisit the investment theses of my holdings. By recapping, I force myself to remember why I own those stocks—a proper exercise to reinforce my conviction to hold or think harder about selling.

For each position, I have also included key metrics as objective indicators to check if my thesis is playing out or not.

So, to my brief recap:

• Franklin Covey (FC): Franklin Covey provides educational services to businesses and schools. The company is transitioning to an online subscription model that is scalable, recurring (churn is <10%), and higher-margin. Due to COVID-19, revenue declined in FY2020 and Q1/FY21, but last quarter saw a 359bps expansion in gross margin. FC has set EBITDA targets doubling from $20mm in FY2021 to $40mm in FY2023. The stock trades at 15x EBITDA, which is undemanding considering the quality of the business and management’s (conservative) guidance of +40% EBITDA CAGR over the next two years.

  Key metrics: EBITDA margin and growth.

• Revolve (RVLV): Revolve is a fashion apparel e-commerce retailer. The stock isn’t cheap (you’re paying ~5x sales for a clothing retailer), but there’s much to like about the business—owner-operators, high ROIC, strong FCF, double-digit top-line growth. Sales declined in 2020 (COVID-19), but with cost control, the company saw EBITDA increasing 25% y/y. I’m wary of Revolve’s competitive advantages and the stock has increased almost 6x since my initial purchase. However, I’m willing to hold. Last quarter, the company posted a +25% growth in international sales. Revolve is building a large business outside the US, which could support higher growth rates for years to come. I won’t bet against high returns on capital and a long runway for growth financed through internally generated cash flows.

  Key metrics: Sales growth and FCF generation.

• Duluth (DLTH): Duluth is a lifestyle apparel retailer. The company’s aggressive brick-and-mortar expansion wasn’t a success but wasn’t a complete failure either. Margins declined, but Duluth is now refocused on getting back its operational efficiency. I like Duluth’s competitive position and brand, carefully built for over 20 years. However, the company sells niche apparel that appeals to a specific consumer set, indicating limited growth prospects. The stock is trading at <10x EBITDA and ~16x normalized FCF. Mean reversion to historical margins could lead to a substantial upside. I’m waiting for Q4 results on March 18 to reevaluate my investment.

  Key metrics: Sales growth and EBITDA margin.

• Research Solutions (RSSS): RSSS provides workflow solutions for scientific research conducted in business and academia. The company sells subscriptions to Article Galaxy, its SaaS platform, and generates transactional fees from articles bought through Article Galaxy. The subscription segment accounts for ~16% of total revenues, but it’s growing fast, with ARR reaching $5mm recently (+35% y/y). RSSS has no debt and doesn't burn cash. The stock trades at an EV of $50mm. Excluding the transaction business, which could be worth ~$30mm, I’m paying <5x sales for a SaaS segment that’s growing +25% y/y at 80% gross margins, with <10% logo churn and >100% net revenue retention. Given its $10mm cash balance, I expect RSSS to announce acquisitions over the next 6-12 months. This catalyst could accelerate growth, attract sell-side coverage, and increase liquidity in the name.

  Key metrics: ARR growth.

• Facebook (FB): Last year, Facebook generated $24bn in FCF while growing sales by 21%. The balance sheet is a fortress, Zuckerberg is a clever capital allocator, and there’s significant optionality from WhatsApp, payments, VR, a large cash balance, etc. Sure, there are risks associated with regulations, iOS changes, and the decay of Facebook’s social platforms. And yes, growth rates will probably slow down because there aren’t that many people on earth. But at current prices, we have a high-quality business yielding 3.5% in FCF and trading at <14x EBITDA. Market expectations regarding FB are too pessimistic. It’s a battle between good fundamentals and bad sentiment. Something has to give.

  Key metrics: FCF yield and EV/EBITDA — my focus here is on valuation and implied market expectations.

• Tesla (TSLA): Tesla is my highest-conviction stock, meaning I won’t sell unless something material and out of the blue happens. I already realized significant gains on the stock, it’s fun to own, and the company’s future is a big unknown. Car production volumes are growing; factories will soon open in Germany and Texas; customers love the cars; there’s a promising pipeline of products coming up; FSD is encouraging (check YouTube videos); the energy business is booming; the balance sheet is strong; access to capital is cheap. Does the valuation make sense? I don’t know. You’re paying 170x P/E for a car manufacturer (is it only a car manufacturer?). Yet, there’s growth, reflexivity, operating leverage, autonomous fleets, insurance, energy. Who knows? We’ll have to wait and see.

  Key metrics: Car deliveries and auto gross margins.

• Twitter (TWTR): The value of Twitter as a platform is so much higher than the price of its stock. Management needs to move faster to unlock that value. With new activist investors on the board, changes are brewing. The company had an Analyst Day and divulged some of its goals for the next couple of years: accelerating revenue growth, doubling development velocity, acquiring more users. Since I’ve bought, the stock has doubled, but Twitter’s market cap is only $60bn, while Snap is worth $100bn. There’s plenty of upside to be had as long as management executes.

  Key metrics: ARPU and user growth.

• Berkshire Hathaway (BRK): Berkshire provides diversification through a series of businesses it owns: insurance, railways, retail, oil, even Apple. BRK has a large cash balance, which could be put to good use if the market suffers a significant correction. In that sense, it’s counter-cyclical, as long as you’re willing to hold through a downturn period. Significantly, BRK was purchasing back its stock. Who better than Warren Buffet to know that BRK is a good buy at these prices?

  Key metrics: Cash balance and buybacks.

• RCI Hospitality (RICK): RICK operates nightclubs and restaurants. RICK buys nightclubs at 3-4x EBITDA and finances a portion of the purchase with a seller's note tied to the nightclubs’ cash flows. There are ~500 nightclubs in the US that fit RICK’s target market. The company can keep buying them for years to come, with unbelievable ROIC. On the restaurant front, RICK owns Bombshells, a concept that performed well during the pandemic. There are ten Bombshells in the US, and RICK targets ten more over the next three years. There’s also an attractive potential for franchises (one agreement already in place). Management has a clear capital allocation framework to decide among buying back shares, reinvesting cash flows, or paying down debt. Before the pandemic, FCF/share was growing 25%. On a normalized basis (no COVID), RICK should generate ~$50mm EBITDA. The stock trades at 10x that.

  Key metrics: Sales per unit (nightclubs and Bombshells), operating margins per segment, and FCF/share.

• MSOS ETF: US MSOs are growing triple digits and trading at a considerable discount to Canadian peers. The US cannabis sector will likely re-rate as MSOs uplist to the Nasdaq and NYSE. Capital will flow to the industry, the cost of capital will decline, and multiples will expand.

  Key metrics: MSOs sales growth and P/Sales multiples.

• Crypto: Speculative investment. A call option over an unknown future.

  Key metrics: Musk’s tweets.

Thanks for reading,

Fred.