Disclaimer: This note is intended for US recipients only and in particular is not directed at, nor intended to be relied upon by any UK recipients. Any information or analysis in this note is not an offer to sell or the solicitation of an offer to buy any securities. Nothing in this note is intended to be investment advice and nor should it be relied upon to make investment decisions. Cestrian Capital Research, Inc., its employees, agents or affiliates, including the author of this note, or related persons, may have a position in any stocks, security or financial instrument referenced in this note. Any opinions, analyses, or probabilities expressed in this note are those of the author as of the note’s date of publication and are subject to change without notice. Companies referenced in this note or their employees or affiliates may be customers of Cestrian Capital Research, Inc. Cestrian Capital Research, Inc. values both its independence and transparency and does not believe that this presents a material potential conflict of interest or impacts the content of its research or publications.

And We Don’t Care About The Young Folks

Hats off to ARK Investments’ CEO Cathie Wood. Now in her sixties, she founded and still runs an investment firm that has aced the new generation of internet and other tech stocks. If you don’t know of ARK or Cathie Wood – and shame on us, we did not until a couple years back – you should. You could start by reading this piece. And you could move on to reading our own recent note on Seeking Alpha about ARK’s largest ETF, being ARK Innovation (NYSEARCA:ARKK).

Here at Cestrian, a technology- and space-focused business, our natural affinity and understanding leans to the enterprise. Our firm exists to publish the proprietary buyside research that we prepare for our own personal investing and trading activities; and so our coverage universe leans toward enterprise stocks. In software, we can develop an understanding of a new-name vertical or horizontal enterprise play pretty quickly. We know what good looks like in terms of growth rates, gross margins, cash generation, customer contract structure, deferred revenue and importantly how all those metrics relate to one another and how top-class management teams can best juggle those metrics to maximize value. And we’re not technical analysts but we can draw a couple colored lines on a chart every now and then. So, show us a new-name enterprise software stock, give us half an hour or so and we’ll give you a quick take that will very likely stand up pretty well to far more intensive subsequent analysis.

There is, of course, a whole other category of technology stock, being those driven by consumer spending. And for the most part it’s spending by younger consumers who put their time into activities that, honestly, bemuse us. We know, for instance, that people like to take photographs of breakfast and post them online, but we have no clue why they like to do this. And even less of a clue what kind of nonsense they might like to do next week when they tire of trying to make today’s avocados look more interesting than yesterday’s. Bunny ears on your selfie? Why? An online pinboard of stuff you find interesting? That’s seriously the most exciting thing you have to do today?

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You could put this down to our age but to be truthful we were the same when we were younger. We’re old enough to remember the 2004 sale of a company called Jamba! to VeriSign (VRSN) for $273m which at that time bought you more than a modest single family home in Palo Alto. Want to know what Jamba! did? It sold something called ringtones which you could install on your not-very-smartphone. And their big seller? Crazy Frog. $273m, ladies and gentlemen, in old money.

We like making money and we know that one can make big money from things like Crazy Frog. But we cannot motivate ourselves to put time into trying to understand consumer internet stocks, so we don’t bother. We either trade their stock charts – because a chart is a chart is a chart, all the same rules apply regardless of what the underlying company actually does – or if we want to hold these stocks for the long term, we would sooner outsource the judgment as to which stocks to hold, in what proportion, when to buy and when to sell etc. There’s lots of ways to do this but our preferred way is to pay a paltry 0.76% of the relevant allocation to Cathie Wood and team at ARK, who will do it all for you. The past being no guide to the future, they will succeed or not succeed, but they are completely focused in this new world and in our experience, focus is a necessary condition of success in technology investing. And so far, that team has succeeded, with bells on. We think they are likely to continue to do so. Because what you are really investing in when you pick a managed ETF is the fund management team. The underlying stocks are a consequence of the team you backed. And in fund management, people who have been successful for a long time tend to keep on being successful. They might have a bad quarter or a bad year, but they tend to bounce back. So we have long-term confidence in ARKW for as long as this ARK team is managing it.

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Here’s how ARKW has performed vs. the Nasdaq proxy ETF, QQQ, in the last five years.

Source: YCharts.com

In a stellar run for the Nasdaq, ARKW has trounced it – and consistently so, not punctuated by excessive volatility. The runaway success in 2020 may or may not be repeatable – likely not – but the delta to QQQ is in our view explainable by a simple concept. Grandpa Tech. We would love to have coined this phrase, but we didn’t. It was coined by a fellow chatroom user. Grandpa Tech refers to what are now old-line names that dominate the Nasdaq. The companies are for the most part 30+ years old and in tech that is legacy-in-waiting. The holdings in ARKW, much younger and as a result much growthier.

QQQ Top 10 Holdings

Source: Seeking Alpha

ARKW Top 10 Holdings

Source: Seeking Alpha

In a bull market, which we have surely been in since money became free in 2009, younger and fast growth beats Grandpa Tech most days. For a while in Q1 of this year it looked like Grandpa might be a dependable source of cash – for instance Cisco (CSCO) offered to extend majorly long credit periods to customers committing to buy their kit rather than boxes from younger players like Arista Networks (ANET) – but once it was clear that the digital shift had been accelerated by the COVID crisis, not interrupted – then, those younger names soared away.

ARKW’s top holding is Tesla (TSLA) – this has been the case for some time. You might say, that’s a one-time win not likely to be repeated. You might be right. But we think not. We think it’s the quality of ARK analysis that led them to hold TSLA in such proportions to begin with. That fund management team point, again.

TSLA is in our view such an emotionally charged stock that the best way to treat it is completely unemotionally. Is TSLA worth what it’s worth? Is any stock worth what it’s worth? The answer to both questions, right at the moment of asking is, yes. Because what a stock is worth isn’t a fundamental question, it’s a relative question. And it’s a circular question. A publicly-traded stock is by definition worth what it’s worth. We applaud ARK’s cold assessment of TSLA some years back. At the time we ourselves were darting in and out of the stock, taking gains here and there, always concerned that Musk’s latest antics could send the stock sprawling. Also, being given to fundamental analysis, we always used to look at the TSLA balance sheet and say, er, how come nobody else is worried about this? But once the company found its feet through 2019 and in particular once it proved able to raise serious capital without heavy dilution, we relaxed somewhat. And since Musk was handed a compensation plan that, should he deliver sufficient stock price appreciation, would make him the richest human on Earth, the Moon and Mars combined, we figured, wild horses couldn’t hold him back from achieving that. So we stopped worrying about owning TSLA and just sat back to watch Musk do his thing. It was a good call. And at the time of writing he is only the second richest space cadet, so we think there’s quite some growth left in the TSLA stock price. ARK got there way before us and this is one of the reasons ARKW has delivered such solid performance. That’s after they’ve been selling down their TSLA position to maintain a sub-10% allocation. TSLA is in QQQ but even now it’s only at 3% allocation.

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Risks abound, of course. The nature of ARKW’s holdings is that they are high-beta. If disaster befalls the economy and/or the market, it’s possible that ARKW is hit harder than most (see for instance the bigger-than-NASDAQ-drop in Q4 2018 and Q1 2020) but we believe that taking a long-term view can ride that risk out. In the end, the specific names, and types of company, in the ARKW portfolio are likely to continue to grow faster than the mature Apple (AAPL) and Microsoft (MSFT) type names in QQQ.

The biggest single risk is the disruption of the fund management team. As much discussed in the comments to our prior note on ARKK, there is a tussle over control at ARK right now. Our money is on Cathie Wood to prevail – if she and her team remain managing ARKW, we remain at Buy.

Cestrian Capital Research, Inc – 1 December 2020.

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Disclosure: I am/we are long ARKK, ARKW, CSCO. Business relationship disclosure: See disclaimer text at the top of this article.

Additional disclosure: Cestrian Capital Research, Inc staff personal account(s) hold long position(s) in ARKK, ARKW and CSCO, and short hedge position(s) in QQQ.



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