As always, this is not investment advice! Please do your own due diligence and take your own financial situation into account. Everyone has a different financial situation, which means different tolerances for risk and ability to take risk. What is appropriate for me may not be appropriate for you.
Last month, the Paper Portfolio took a marginally more conservative stance due to uncertainties around the debt ceiling. At the time, Capital Flywheels believed politics would likely lead to a higher-than-comfortable probability that the US could breach the debt limit…even if just for a day. While it did come down very close to the wire, the US government got a deal done just in time (partially helped by a slight extension of the estimated debt ceiling “X date” from 6/1 to 6/5).
Despite the marginally more conservative stance, the Paper Portfolio performed exceptionally well as both the debt ceiling and Fed rate hike pressures abated in May. Despite the marginally more conservative stance, the Paper Portfolio still performed exceptionally well as the Paper Portfolio has been aggressively positioned for a rebound in long duration assets since 2nd half of 2022 as it became clearer that inflation had peaked, rates were on its way to peaking, and valuations were bottoming.
In addition to these macro factors, the Paper Portfolio also benefitted from a significant broadening of the AI theme during the month of May. The Paper Portfolio has been positioned aggressively to participate in the AI theme since early 2020 while further expanding the bet earlier this year. Nvidia had already seen stellar performance since the beginning of the year (and up 5.7x since we added in March 2020), but May also saw broadening of the AI theme to include names like Marvell (added at end of Feb 2023), AMD, and Cloudflare.
Together, the macro and micro factors helped the Paper Portfolio return 17.8% during the month of May vs 2.9% for the SPY. This brings YTD returns to 33.4% vs 12.3%, respectively. The Paper Portfolio remains behind the SPY on a “since-inception” basis with returns standing at 38.6% vs 53.1%, respectively. However, this is the narrowest performance gap since April of 2022 following the aftermath of the Ukraine war impact on equity markets.
Turning to individual names, some of the key top contributors to highlight include:
1/ Cloudflare – Cloudflare returned 50.1%. After declining significantly towards the end of April on the back of weak results / guidance, the company reignited investor interest with an Investor Day event along with new product / service launches around security and AI. One of the most interesting announcements was the revelation that many leading AI companies including OpenAI and others increasingly prefer to store their data on Cloudflare’s R2 service since it allows them to better access GPU processing power no matter where it is available. This is much harder / more expensive to do if data is stored on, for example, AWS, while trying to access GPU capacity on other clouds (e.g. Azure, GCP, etc). Cloudflare’s infrastructure is becoming more and more critical for how the internet is evolving.
2/ Nvidia – Nvidia returned 41.7% as the company delivered strong quarterly results and absolutely stunned investors with an unbelievably strong Q2 guidance, primarily driven by datacenter segment. Not only is Q2 guidance unbelievably strong, the company further expects datacenter results to further strengthen in 2nd half of the year. As a point of comparison, the Q2 revenue guidance was almost as large as the revenues for all of FY2020. And 2nd half is expected to be even stronger.
3/ Marvell – Marvell returned 52.4%, the single best performer in the portfolio this month. While the company reported another quarter of fairly average results, the company noted that AI is creating significant demand for their datacenter products that will likely benefit results in the coming years. The demand is so strong that the company now expects AI-related revenues to grow at 100% CAGR between 2023-2025. We added Marvell to the Paper Portfolio earlier this year since Capital Flywheels believed higher semiconductor exposure writ large made sense in the face of growing AI demand, and Marvell would likely be a significant AI beneficiary (that was overlooked by the market).
4/ Nextdoor – Moving away from the AI theme now, Nextdoor returned 33.7%. Nextdoor reported weak but better-than-expected results that suggest improvements are likely on the way for both revenues and profits. Although the company continues to report weak results, the stock remains severely mis-priced given the company’s strong balance sheet and sizable long-term potential.
5/ Uber – Uber returned 28.0%, driven by strong results and guidance. The company is now delivering meaningful free cash flow, while seeing profits inflect upwards. After years of disappointment, the company is now delivering on promises and refuting bear arguments that the business model is broken and can never be profitable. The company previously guided to $5 billion of EBITDA by 2024 (which may roughly imply about $4 billion of free cash flow)…which the company now looks likely to exceed.
On the naughty side, only one major stock stood out:
Sea – Sea declined 22.0% in May. Although the company reported strong results, investors were unnerved by a potential return to investing in the business. Over the last 6 months, the company has drastically cut costs in a bid to become profitable. The company achieved that far ahead of schedule. While the company is unlikely to return to losses going forward, profit improvements may now subside as the company reinvests for growth at the margin. Investors may be concerned about trading in profits in hand for an uncertain number of birds in the bush (e.g. how much will revenues reaccelerate given the investments?). While the move in the stock is disappointing, Capital Flywheels remains confident in Sea’s long-term future.
In terms of position changes, the Paper Portfolio will add a 3% position in TPL (Texas Pacific Land). TPL is an oil and gas business with assets located primarily in Texas. The company has a long storied history beginning as a railroad that later ended in bankruptcy. Initially set up as a trust to liquidate land initially held for railroad use, it found a second lease on life after the US shale boom led to significant growth in value for their land assets. Today, TPL primarily operates as a royalty company, collecting royalties for every barrel of oil and gas (and other minerals / resources) extracted from their land by others. This is a highly attractive and asset-lite business but is sensitive to oil price. While Capital Flywheels does not usually prefer owning commodity-exposed businesses (as a demonstration of the enormity of the mistake: Years ago, before I started writing this blog, Capital Flywheels initially discovered this business in 2013 when it was ~$80 per share. However, during the course of research, the stock quickly bounced to $90, which I passed on out of spite. I kept rationalizing that I shouldn’t chase a commodity-exposed business. TPL eventually peaked at $2.7k late last year (30x higher than the $90 price I passed on), before declining this year to a still life-changing $1.3k had I been more openminded.), TPL is a higher quality asset that will give us some protection in case oil and gas prices rise in the coming months / years. Recessionary forces may make this a bad bet, but at the same time, the supply of oil continues to face headwinds due to a lack of investments in this space. Operators are rightfully concerned about investing in oil supply growth against the broad global push to transition away from oil and gas. While this may be the reality in the long-term, there may be moments in between where we will suddenly discover we don’t have enough oil and gas before the reliable renewable green energy bridges the gap. Lastly, oil and gas are important hedges against further escalation in geopolitics. If global trade continues to get disrupted or, God forbid, more war breaks out, oil and gas are likely to spike.
Let’s see what June brings.
Disclosures: Of the stocks mentioned, I own shares in NET, PINS, SE, KIND, MRNA, U, SDGR, OKTA, SNAP. I have no intention to transact in any shares mentioned in the next 48 hours.