🩸 Blood, profitability, options, and valuations

The demand for sanity returns

blood in the markets


So it turns out, that in the end, markets actually do care about valuations and free cash flow.

Who would’ve guessed ¯\_(ツ)_/¯

Each of these companies got spanked this week in its own unique way, but it all kinda rhymed. It all came down to profitability, at reasonable prices.

A few things that caught my attention

1. Underwater Options​Almost all big tech companies have been paying their employees with options (essentially shares). The problem is that a lot of the options are underwater now that the stock prices have sunk so much.​Essentially a lot of these employees ended up making far less than they had planned. Expect to see some different forms of compensation in the future, both as employees don’t want to get shafted, and as investors finally revolt (see next point).​

2. Stock-Based Compensation (SBC)​It’s been a free-for-all of poor financial stewardship for years now. $SNAP has been one of the worst, and investors are over it.

SNAP stock crashing

A huge chunk of this comes down to how the companies are paying for their expenses (employee compensation). It’s not all coming from revenue, that’s for sure. Massive amounts of it are coming from the issuance of new shares.

To put this in perspective, Snap issued over $1billion in new shares in 2021, mostly to pay the insiders. Every new share created dilutes the value to existing shareholders (cutting the same pie into smaller slices).

As a crazy example, in 2017 Snap lost $720M, but Even Spiegel awarded himself $636M in new stock.

3. BuybacksBuybacks get a bad rep, but the intelligent practice of buybacks can make a lot of sense. It can be a tax-efficient way to return profits to owners. By buying back shares, companies are essentially making the remaining slices of the pie bigger, entitling each remaining shareholder to a greater ownership share of the company.

The problem with buybacks comes when companies simply use them as a way to cover up the SBC mentioned above, OR they do buybacks at too elevated a price. The problem is when CEO’s use them as ways to try and game the markets.

Here is a fantastic thread explaining how META botched this up, and abused shareholder capital.

Capital Allocation, Silicon Valley Style. Myriad reasons for $META's 74% Faceplant, but consider the abuse of the shareholder for capital allocation gone haywire. 2017 was apparently the right time to initiate repos. EVERY share bought, by the firm, or anybody, is underwater. 1/

— Christopher Bloomstran (@ChrisBloomstran) October 27, 2022

It’s worth reading, but the TL;DR is that Facebook used almost 78% of its profits to buyback stock over the last 6 years, but they did buybacks at a significantly higher share price than today (bad investment), AND the total amount of shares barely even went down due to all the SBC being issued.

SNAP tried the same buyback strategy (charade) but the results are even worse, and the share count still grew massively.

4. Profitability and ValuationsFor the last little bit of this tirade, we’ll turn to AMZN and META together. Both of these truly are amazing companies that swim in oceans of earnings. The problem right now, and one reason why the market punished them so hard this week, comes down to valuations and profitability.

For Amazon, it’s not that the company suddenly became a big cash suck, it’s simply that its growth slowed down. When something is growing like a weed you can pay a lot more for it. But, when that same thing slows down (as all things eventually do), valuations have to come back to earth.

Add to that all the king-sized capital expenditures the company has and the outlook can change.

Meta is similar. It shits cash, but with Zuck spending insane amounts attempting to build out his metaverse vision, there are a lot less profits available for shareholders. This is despite investors’ pleas to limit Meta’s capital expenditures to reasonable levels, as was demonstrated in this viral open letter to Zuckerberg by Brad Gerstner of Altimeter.… which Zuckerberg essentially just said “nah” to.

AMZN and META are two of the greatest companies of all time, but just because they are great doesn’t mean that they are great at any price.

Add to that general market nervousness, a slowing economy, and the risk-free rate of treasuries getting close to 5%, and investors have a lot more options to consider.

The Last Day for 9.62% iBonds

This one is only for Americans (and residents), but the Series I Savings Bonds (inflation-protected government bonds) are getting the interest rate reset next week. It’s currently 9.62%, but is expected to drop to the 6.x% after that.

If you want to lock in the rate, better move quickly. It’s mostly limited to $10k per person per year.

*Note* the TreasuryDirect website is crashing some under demand, so you may have to be patient.

What happened in China this week

​One of my favorite things I read is this weekly Twitter thread on what all is happening in China.

(spoiler: there is always a lot happening in China)

I think it’s wild to see all the crazy shit that goes down, the juggling of the massive debt and economy, the strategy of long-term Chinese values, and a lot more that I never expect.

China is just super fascinating to me. It has such a huge impact on the rest of the world.

Sofia’s boots-on-the-ground (via HK) perspective is worth a read:

One more thing:

I love my AirPods. I have two pairs, and basically live in them.

This quick little hack made them even better.

I made a 2-second change and now my audio sounds way better than before.

That’s all I’ve got.

Until next week's newsletter,​– Travis