June 2022 – Yesterday’s War

Hoping for unprofitable growth companies to lead again is fighting yesterday’s war

Unprofitable growth companies continue to grind lower in 2022. This brutal bear market for the once high-flying issues is a painful dose of cogitative dissonance to those used to easy gains on exciting companies. Rather than cutting edge technologies like artificial intelligence leading markets, in 2022 boring is the new black. Unexciting companies like H&R Block, (taxes) McKesson, (pharmaceuticals) and CVR Energy, (oil refining) are posting spectacular returns for the Frank Value Fund. There are no points for difficulty in finance, and as investors are finding out, exciting technology does not mean guaranteed gains.

From Dinosaur to Superstar

In the 2002 movie, Signs, director/writer M. Night Shyamalan crafts an alien-invasion story from the perspective of a family. Each member of the family has strengths and weaknesses when it comes to the invaders, but the youngest, daughter Bo Hess, played by Abigail Breslin, mostly leaves glasses of water around the house. This habit annoys the rest of the family but goes from useless to life-saving when an alien enters the home and the family figures out aliens are harmed by water. This is the sea change we have witnessed in investing in 2022. During the growth-mania, value-investors wandered around their homes, muttering about fundamentals and cashflow, leaving these annoying glasses of water everywhere. Now, with rates rising, inflation roaring, and the economy slowing down, seemingly everyone wants fundamentally sound businesses with strong cashflows. Investors clinging to the bull market, hoping for unprofitable growth companies to lead again, are fighting yesterday’s war.

The New Rules

Inflation may have peaked but it is still uncomfortably high, especially for most Americans whose wages are slow to increase. The Federal Reserve has shown no signs of abandoning its rate increases despite an S&P 500 down double digits. Higher rates, combined with the ugly twins of inflation and a weaker consumer, drastically change the investment landscape. We believe this specter will loom over markets for longer than investors expect. Therefore, there is no going back to the way things were. Limitless QE, spiked punch-bowls, and the never-ending bid for risk assets have been terminated. The new rules of investing are the old ones: quality profits, attractive valuations, and competitive advantages. Investors clinging to Enterprise Value to Sales ratios and metrics like Total Addressable Market are fighting yesterday’s war. The dynamics of today’s stock market require “what have you done for me lately” fundamentals like sustainable dividends, significant stock repurchases, and cold, hard cash flow.