Get your Buffett hats on for this one. Technological Toll Bridges! Why some of the best hedges against inflation may be hiding in Big Cap Tech!
{DISCLAIMER and RISK WARNING}- On the date of the publication of this article, I did not have (Directly or indirectly) any positions in ANY of the securities mentioned in this article. The opinions in this article are my opinions and DO NOT constitute a recommendation to buy, nor is this article to be viewed as investment advice. The views in this article are merely my opinions that I am sharing with you for educational purposes only. All investments pose inherent risks and it is the responsibility of the investor to weigh these risks before making investment decisions. -AK
By Andrew Kennedy Oct. 17, 2021
Someone recently gave me this example on how to think about the stock market during inflationary times, and I thought it was such a profound way of forward thinking (the kind of thinking that makes people rich) that I figured I would share it with the few who might actually read this blog. The Stock Market is a forward thinking and pricing tool. It is always a step ahead. Everything new that happens is seemingly already priced in somehow. That is why they say, “Buy the Rumor, Sell the news.” The stock market seems to have an uncanny way of knowing what the news will be, before it is even a rumor. It always seems to preemptively adjust prices before the public knows what is going on. When investing you need to always be thinking one step ahead. Like a carpenter who builds stairs. #Narddawg No seriously, you must try to be a forward thinking investor. Think of investing like a game of Chess. You need to always try to anticipate what is coming and plan a few moves ahead of where we are now. So let us Bobby Fischer this inflation fear real quick, think a few steps ahead about potential fears that will inevitably cause investors to panic-sell in the very near future, and get your mind thinking in the right way to make some money.
When the stock market is down big, mostly ALL stocks are negatively affected. Good stocks tend to always bounce right back when the market does and sometimes even breakout to new highs. I will write about investment and trading strategies, how to analyze stocks with fundamentals and technical analysis in future blogs. Right now I just want to get you to try think like I am thinking for a little.
What if I told you that perhaps some of the best hedges for inflation may be hiding in a place where most rational investors would never consider looking… in BIG CAP TECH? You would probably call me the R word. I am being completely serious though. ! Inflation hedging gems hiding right out in the open, in the last place you would ever think to look. So lets take a look shall we? In the words of the Mandolorian, “This is the way!”
Tremendous rapid growth and future earning potential makes Big Cap Tech the place to be when times are good and the market is soaring to new highs on the regular. Growth costs capital but when capital is cheap and easy to come by like it has been during this Covid stimulus bubble, it makes the tremendous returns on high growth stocks worth the high prices and elevated risk! But in an inflationary environment where interest rates are poised to rise and the cost to borrow capital increases… the future profitability potential in Big Cap Tech and other hyper growth companies decreases significantly. Therefore the risk involved in investing in big cap technology stocks usually increases dramatically with rising interest rates. Almost every time there is worry in the markets about rising interest rates, Big Cap Tech gets hit first and it gets hit hard, making it the last place most people would ever think to look when considering a hedge for inflation. With rising interest rates currently looming on the horizon in the upcoming months, and the fear of inflation running rampant both signs point to imminent market sell offs within big cap tech.
People ultimately trim their riskiest positions first, meaning Big Cap Tech is usually the first to go, but that also means there will be amazing opportunities to buy the RIGHT Big Cap Tech stocks at a fantastic discount from where they are currently trading and priced. But you will have to tune out all of that noise and fear. So I thought I would take the time to explain to you the thinking behind why some of the most perfect hedges against inflation may be secretly hiding in Big Cap Tech. Tis a mathematical certainty that you will get some great buying opportunities in the near future, if you aren’t afraid to pull the trigger when everyone else is jumping ship because of inflationary worries that they maybe shouldn’t have about these companies. There is currently other kinds of pressure on these same stocks that may also combine to create an ideal scenario to the forward thinking investor. So put your Warren Buffett hats on and learn about the digital toll bridges right in your palms and I am not talking about Apple!
During inflationary times there are some key aspects of companies to look at like Capital costs, Input costs, Pricing Power, and Interest Rates. A capital cost is a one time expense incurred to manufacture a product or service. An input cost is a recurring expense needed to produce a product or service. During inflation, investors want to look for solid companies that maximize their capital costs effectively and minimize their input costs. You also want companies that have loyal brands and can raise prices without affecting sales. Warren Buffett loves him some Pricing Power! And you want to look at Interest rates. Companies that don’t currently generate a lot of cash are often forced to borrow capital to maintain growth on their push to profitability. When interest rates are higher the cost to borrow capital increases and an investor can reasonably expect companies with those kinds of capital needs to be less profitable during these times.
Warren Buffett once famously said, “In an inflationary world, a toll bridge would be a great thing to own because you’ve laid out the capital costs in old dollars and you don’t have to keep replacing it.”
A toll bridge also has plenty of pricing power, and has little to no input costs. People won’t stop using toll bridges because of price increases because the service is still wanted and needed. People still have to get where they are going. On the other hand, during inflationary times people will stop buying certain products if the price increases. So in the mind of one of the most famous and successful investors of all time, the type of business you would ideally want to invest in during inflationary times would be a business with a model similar to that of a toll bridge. Enter Big Cap Tech and its potential digital toll bridges. Facebook and Google are the examples I have chosen. I personally think of both of them as the modern technological Toll Bridges!
Customers won’t stop using Facebook (Instagram or WhatsApp) or Google (YouTube) because of inflation. Toll Bridge. They have low capital costs compared to other enormous companies. Their infrastructure has already been built. Fixing a code isn’t as expensive of a problem or as worrisome as securing capital to build factories that manufacture semi conductors because of chip shortages due to our trade beef with China. A lot of tech companies will be forced to contend with that nightmare scenario! Toll Bridge. They both have relatively low input costs for their products. They don’t have to worry about expenses incurred during all of the supply chain bottlenecks and constraints that say an Apple, Microsoft, Tesla, or other big cap tech companies with higher input costs are no doubt already experiencing and will have to ultimately pass on to the consumer. Toll Bridge. Facebook and Google also have enormous control over their Pricing Power and can essentially raise prices to advertisers if they choose to at will without everskipping a beat. At the end of the day, NOONE can reach people like Facebook or Google. Toll Bridge. The services they provide are free to their users, because you are the product. If you are unfamiliar with the business models of basically any social media or tech company these days.. essentially you are actually the product that they sell. In the most basic terms imaginable- Google and Facebook and all of them collect, compile, and analyze data points based off of every interaction you make on their platforms. Every like, search, share, tweet, poke, etc is analyzed and filtered based off of your interests so that they can effectively sell what you are most likely to buy to advertisers) They won’t experience less sales or profits like virtually every other Big Cap Tech company will see as a result of inflation. I would argue that the services Google and Facebook provide to their clients become even more essential in an inflationary environment. The need for the most efficient and cost effective advertising becomes of the upmost importance when every penny suddenly now matters. Toll Bridge.
Once you get past the questionable (and sometimes crossing the line) ethics behind the business models of both Facebook and Google, you quickly see that they are CASH GENERATING MACHINES, and it certainly appears that they simply cannot be stopped. Their brands are dominant and sometimes even used as synonyms for the entire respective technology sectors that they have conquered. These two examples are both admittedly kind of icky and have had their share of controversies. Both share some guilt and responsibility for their roles in some of horrible events that have transpired recently. They are at very least guilty of displaying gross negligence on a massive scale. Whether it be with the Capitol Riots, the Cambridge Analytica scandal, Covid misinformation, or even internal Facebook memos citing their awareness of studies showing that they may be a root cause of the significant increase in depression and self esteem issues the younger generation is facing (especially adolescent females.) They have definitely earned the government scrutiny and any potential regulations placed on them in the future. But then again, this isn’t their first rodeo. Despite numerous controversies in the past, they seemingly always find a way to overcome all odds and race to new record highs. Facebook basically always trades at a discount relative to its peers in the sector for the simple fact that you always have that constant regulatory and government worry over your head. The market already has that kind of uncertainty priced in for the most part. (I think Facebook roughly trades at about 18x forward earnings. Most big cap tech stocks trade somewhere in the realm of 25x forward earnings. I’m not really sure, so don’t quote me on this, but I want to say that Tesla is currently trading at something like 200x forward earnings or somewhere in that vicinity.)
If the investor in you can look past the scrutiny, controversies, regulations, and inflation fears, you may be presented with a perfect storm/dream scenario to start or add to a position in either or both of these companies. If you are seeking aggressive future potential returns, you should be thinking like I am, but make sure you believe in the company’s future and their ability to overcome the odds. And even then you still need the stones to buy it when it looks like all hope is lost and the wheels are falling off. That is when I will be buying stocks! Before making any trade or investment you should always do your own due diligence. Your decision should always first be weighed by your risk/reward tolerance in conjunction with your investment strategy and goals. Have a plan and stick to your plan. Once again this blog is not sound financial advice. I haven’t even been investing for a full year yet. I am merely trying to get you to think differently from most investors. I am trying to get you to think the way investors who have made fortunes in the stock market think. The way that I have been trying to think! Toll Bridges. You don’t have to be afraid of the stock market, but you do have to be very aware of what is currently going on, while simultaneously thinking a few moves ahead, and sticking to a plan that fits your goals.
TheKennedySpot 