👉 Week in Review: 10/30/22
"We’ve had a hurricane behind us for 30 or 40 years, and it’s reversing" ...
Seek out perspective and keep a calm demeanor.
You may recall our words from a post at the beginning of October:
We lean short-term (next few weeks) bullish and bigger picture bearish.
A lot of funds and money managers have gotten wrecked this year. They have clients and constituents that pay a pretty penny for capital preservation. We think a little bear market rally is on deck soon — which will mostly be used as institutional exit opportunities before a bigger collapse to the downside.
What’s happened since?
The Dow Jones Industrial Average had one of the best months in its history:
2. The S&P 500 rallied for the majority of the month, despite generally disappointing earnings / guidance from Alphabet, Amazon, Apple, Meta, and Microsoft (breakdowns of each below).
For what seems like the 20th time this year — antsy investors are calling for a Fed pivot toward being more dovish with its approach to rate hikes.
How are we feeling?
Confident. We believe the large amount of investors declaring that a ‘bottom is in’ are not properly accounting for the continued effects of rate hikes, the need for unemployment to rise, currency issues around the world, and many of the other issues that remain present from this post in June.
An interesting viewpoint:
Click below to watch legendary investor Stanley Druckenmiller explain why he is generally bearish and investors for the next decade or so could face a much less accommodative trading environment:
No time to watch? Here’s the most important quote:
“I’m not saying go get another job and you can’t do stocks. I’m just saying we’ve had a hurricane behind us for 30 or 40 years, and it’s reversing.
And I wouldn’t be surprised – in fact it’s my central forecast – that the Dow won’t be much higher in 10 years than it is today… We are in deep trouble… If you look at the reversal I just talked about and you use a CBO estimate with rates of 3.8%... by 2027, the interest expense alone on the debt eats all healthcare spending.
By 2047, it eats all discretionary spending… We’re getting to the point now when the interest expense on the debt is so high that it’s going to eat up our ability to serve the next generation – and I’m not even sure about the current one…
We’re going to go from all of this QE to QT, we’re following an asset bubble, we’re doing all of this running down of the Strategic Petroleum Reserve (SPR)...to me, the risk reward [of broadly owning assets] is difficult right now.”
— Stanley Druckenmiller, Former Chairman of Duquesne Capital
Week in Review — Too Long, Didn’t Read:
3M is an income investors dream, Google’s cloud business is firing on all cylinders, Amazon told us we’re in a recession, Apple’s margin remain strong, Meta is spending $100B next year, Microsoft’s cloud business is losing steam, Elon Musk is officially Chief Twit, gas prices at the pump might climb higher sooner than expected, GDP beat expectations, people are still spending money, and the housing market is wobbly.
Key Earnings Announcements:
3M remains a top idea for income investors, Google’s cloud business continues to barrel forward, Amazon told us we’re in a recession, Apple’s margins remain healthy despite a strong US dollar, Meta is going to spend $100B next year, and Microsoft might be the first Big Tech company to give it to us straight.
3M (MMM)
Key Metrics
Revenue: $8.6 billion, compared to $8.9 billion last year
Operating Income: $4.2 billion, an increase of +132% YoY
Profits: $3.9 billion, an increase of +169% YoY
Earnings Release Callout
“We delivered sequential and year-over-year margin expansion, amidst macroeconomic challenges and the strengthening U.S. dollar. This quarter we divested our food safety business and began executing the work-streams to successfully spin our Health Care business, resulting in two world-class, public companies.”
My Takeaway
If you’re reading our Week in Review analysis, you’re likely someone who’s always looking for a deal in the stock market. You’ll likely enjoy this hour long podcast episode where I walk through 3M’s business in more detail – so be sure to check that out.
Beyond their business operations – 3M is currently battling a massive lawsuit. Hundreds of thousands of veterans used their defective earplugs several years ago and are now suing a subsidiary of 3M for their hearing loss. People have argued the outcome of this lawsuit has the potential to bankrupt the company – something I’m not at all anticipating. When we aired that episode – from a dividend income perspective, I was bullish on 3M at $107 / share. And I remain dividend income bullish after this earnings release.
The company’s payout ratio is fine, free cash flow is abundant, and their long-term growth profile remains unchanged.
Their stock price will likely continue to thrash up and down – so if you can stomach those type of swings for the next 3-4 years (or until this lawsuit is figured out), you might have a once in a generation opportunity to scoop up shares of a Dividend King paying 5% yield on cost.
Alphabet (GOOG)
Key Metrics
Revenue: $69.1 billion, an increase of +6% YoY
Operating Income: $17.1 billion, an increase of +25% YoY
Profits: $13.9 billion, compared to $18.9 billion last year
Earnings Release Callout
“We’re sharpening our focus on a clear set of product and business priorities. Product announcements we’ve made in just the past month alone have shown that very clearly, including significant improvements to both Search and Cloud, powered by AI, and new ways to monetize YouTube Shorts. We are focused on both investing responsibly for the long term and being responsive to the economic environment.”
My Takeaway
One of my favorite mentions inside of Google’s earnings reports is they always make sure to include their total number of employees. This quarter last year, Google had ~150K employees around the world. Today, that number has skyrocketed +25% to ~187K employees. The results? A +6% bump in revenue and -$5B less in quarterly profits when compared to last year. Wild.
Here are a few of my biggest takeaways from the quarter –
Search revenue came in lower than expected (+4% vs. +8%) and YouTube ad revenue declined year-over-year as advertisers continued to tighten their marketing budgets.
Cloud revenue continued to barrel forward – increasing +38% year-over-year and +9% sequentially.
More negatives than positives. Historically, the company’s largest drivers in stock price appreciation were revenue trends, core margin expansion, and their use of capital. This quarter blurred those lines – a miss on search revenue expectations, cost cutting initiatives clearly lagging economic realities, and margin compression becoming apparent.
Here’s the deal – we continue to believe 2023 will be a year of uncertainty and macroeconomic contraction. However, Google’s core business is now trading ~12X 2023 revenue – while facing minimal competitive risks, healthy long-term margins, and the opportunity to support material stock buybacks. We’re not sure where the bottom is for Google’s stock price – but I’m happy to begin dollar cost averaging the entire way there. If you’re already a shareholder, perhaps selling option contracts could be an interesting way to generate some extra income while this long-term winner shakes out.