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Why Austin Hankwitz is focused on profitability and cash flow (0:20). Russell 2000 is weirdly undervalued (3:10). This is an abridged conversation from a recent Investing Experts podcast.
Transcript
Rena Sherbill: Austin Hankwitz, you host Rich Habits Podcast. Writer for Seeking Alpha. I think it might make the most sense to start broad picture how you’re looking at the markets and then kind of use that as a jumping off point to see how you’ve updated the portfolio based on how you’re looking at the markets and thinking about things, that sound good to you?
Austin Hankwitz: Yeah, of course. So, I think the first big theme I have right now in my brain, it has to do with cash flow, profitability and cash flow. 2022, we saw the stock market collapse because a lot of these, especially unprofitable technology companies, and even the big Magnificent Seven names, even they weren’t exactly called that in ‘22.
But I mean, we saw Meta (META) stock collapse, Google (GOOG) (GOOGL), Amazon (AMZN), Apple (AAPL), they were all trading down 20%, 30%, 50%, 60%. And that’s because they overhired. They weren’t exactly focused on profitability, but instead focused on growth. And we were obviously in this zero interest rate environment. So, everyone was focused on growth.
Well, I would think that now, ‘23, we saw sort of that flip there of, wait a second, the market is now beginning to give a little bit more – sort of assign value rather – to companies who are focused on profitability and cash flow. So in my opinion, now looking forward to 2024, those are the things I’m looking at.
I fully believe that if you can predict the cash flow, you can predict the stock price. I’m not saying that you can predict it one to one here, but if you have general ideas that a company’s operating cash flow, free cash flow, free cash flow margin, things like that are going to trend higher over time, I would also argue that the stock price will reflect that in a positive way over the same period of time.
We saw that with Meta, we’ve seen that with Salesforce (NYSE:CRM). And I think we’ll begin to now see that with DraftKings (DKNG) and SentinelOne (S). I think those are two names recently that have been exciting to me because you think about these sort of new SPAC, newly IPOed companies that we saw in 2020, 2021, of course, the markets didn’t know how to value them, right? The stock prices were all over the place.
And we saw that with all these unprofitable technology names and some of them never bounced back, right? They really, really didn’t. While other companies focused on inching toward profitability, inching toward operational cash flow, things of that nature, SentinelOne’s a great example of that, a cybersecurity company I really like.
DraftKings, they just acquired Jackpocket, which is sort of this like lottery sort of mobile game for $750 million. But they did that because their adjusted EBITDA came in so much higher-than-expected. This quarter is about 22% higher than Wall Street’s expectations when you sort of get rid of this like unusual customers were very lucky during the quarter, right?
But I think that’s just a testament to what these companies can do with this extra money after they’re able to prove that it’s there and they can operate in a profitable manner. So I’m really excited about that.
And the last thing I wanted to sort of talk about as it relates to the markets now in 2024, and Rena, I’m sure you might have a perspective on this as well, but it’s the Russell 2000, right? It’s kind of weirdly undervalued.
I mean, let me kind of explain to you the price action of the Russell 2000 over the last sort of three times that it has dramatically underperformed the S&P, so call it negative 15% in the same period of the S&P hitting an all-time high. So in 1985, the Russell 2000 was down 13%. The S&P gained 17%, the next year in 1986, and the Russell 2000 gained 18%. So it outperformed.
1991 was the same story, outperformed by some 15%, 17% the following year, and then the Russell 2000 did a similar sort of leapfrog by 16% in outperformance in 1999. And again, these were years where the Russell 2000, like we saw in 2023, was in a bear market while the S&P 500 was printing fresh all-time highs, right, doing very well.
So the following year is what I’m talking about, right, where that Russell 2000 catches up and even outperforms what the S&P has done. So I know that was a lot. I’ll pause here, but those were three big things that I’m focused on in 2024 as it relates to the stock market.
RS: No, it’s interesting that your last point with Russell 2000 and small caps, Courage & Conviction Investing focuses on that. And he talked about the kind of transitory nature sometimes of what’s happening in small caps and how to best address that as investors.
What would you say to investors is the most meaningful thing to you about that and how they should be navigating before we get to more specifics on your portfolio?
AH: Yeah, I think at the end of the day, and I’m not going to pretend like I’m betting the market, or betting the farm rather on the Russell 2000. I’m certainly not. And that’s the sort of sentiment I’d share with other investors listening right now, right? It’s like, this is a historical trend.
The Russell 2000 is sort of full of these unprofitable technology companies, a little bit of biotech, right, like these companies got crushed in ‘22 and largely ‘23 was driven by Mag 7. You kind of look at the S&P 493, didn’t perform nearly as well as the top seven, right? So the Russell 2000 is sort of in that group. And I’m sort of kind of leaning back to my first point of profitability and cashflow.
If the Russell 2000 and the names inside of there can begin to inch toward profitability, albeit at a slower pace than the S&P 500 names have certainly been able to do in more cashflow, I think, that’s sort of what I’m focused on. And again, not doing this in a bet the farm fashion, but more as something in a 5% to 7% weighting in my personal portfolio.
