This is an audio transcript of the Unhedged podcast episode: ‘How not to pick stocks’
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Ethan Wu
Every year on the Unhedged newsletter, myself and Robert Armstrong, we pick stocks and in 2022 we did a pretty good job. Last year though, 2023, we really screwed it up. Today on the show: what went wrong last year and how we’re gonna get it so, so right.
Robert Armstrong
So right.
Ethan Wu
So right. This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I’m reporter Ethan Wu here in the New York studio, joined by the man who picks the stocks — good stocks, the ones that go up — Robert Armstrong.
Robert Armstrong
Yes. I love the ones that go up.
Ethan Wu
We avoid the ones that go down, pick the ones that . . .
Robert Armstrong
Not last year.
Ethan Wu
Not last year. That was the problem.
Robert Armstrong
Not last year. I think the metaphor I used is we did not crush the car. We loaded the car with dynamite, drove it off a ski ramp and landed it in an active volcano. That was my metaphor for our stock picks.
Ethan Wu
We were in the bottom, I believe, quintile of . . . So there were a few hundred FT stockpickers. We were in the bottom quintile of total respondents and among FT journalists we were dead last. We ran the numbers on just how bad we did and if you had taken the inverse bet to us, if you had bought the inverse Unhedged ETF, you would have been up 40 per cent in 2023, more than double the S&P 500 performance, which really in itself is an accomplishment.
Robert Armstrong
I know. They should have. I really should get paid for that.
Ethan Wu
That’s rare performance.
Robert Armstrong
Yes. So let’s go through the carnage one corpse at a time. First terrible stock pick, which I will take full credit for, was short Netflix. Here is my view. There is going to be a 2023 consumer recession. Netflix is a very good company, but the streaming video space is crowded with competitors. There’s gonna be a squeeze. It’s gonna get hurt. Opposite happened. Consumers have oodles of money — added subscriptions, Netflix thrived, Armstrong blows up.
Ethan Wu
The stock was up around 60 per cent in 2023.
Robert Armstrong
The horror. OK, moving on.
Ethan Wu
The second one we got totally wrong, and I’ll take credit for this, was short Coinbase. We thought, well, the air’s out of the crypto balloon, the Fed is shrinking its balance sheet, there’s less liquidity in the system. If and when there’s a recession, it’s going to be the next leg down in crypto. And the opposite happened. There was actually a bit of a pick-up in liquidity, almost more interest in bitcoin that the price doubled last year. And so Coinbase stock 3x-ed.
Robert Armstrong
And we should note that the winner — Kadeem, our colleague who won the stock picking contest — I think he owned like all bitcoin miners. Like that was the pick that actually won the contest.
Ethan Wu
He bought the dip in crypto, yeah. Our third short — and this one was a little more subtle, ended up being a big lesson for a lot of people in markets — short PulteGroup. What is PulteGroup?
Robert Armstrong
PulteGroup is a homebuilder. We’ve talked about this on the show before, but I’ll just run through. This was a legit screw-up, not just of the recession call. We thought interest rates going up, housing affordability down, pricing pressure on homebuilders. What happened though is that because rates went up and everyone who has a mortgage at a low rate, like a legacy mortgage, just decided not to move because they’re like, if I move, I’m gonna go from paying, you know, a 2.75 mortgage to a 7 per cent mortgage. No way. I’m staying in this house forever. That means the only houses that are available to buy are new houses and PulteGroup, which makes new houses, has a great year. Sound of car falling off cliff and crashing on the ground.
Ethan Wu
And more broadly than Pulte, homebuilder stocks in general were one of the big trades of 2023. Warren Buffett’s Berkshire Hathaway got into that trade. There’s tons of interest in it. I think it wasn’t broadly expected that this would happen. Ended up being a really interesting trade.
Robert Armstrong
Also, lesson there. It is very, very hard to short any company that has a structural tailwind. The fact is we don’t have enough housing units in the United States. Whatever the particular circumstances of a particular year, you don’t wanna get in front of not enough houses in the form of betting against a homebuilder. I won’t be doing that again.
Ethan Wu
So we bet against three of the biggest winners (both laugh) of 2023 and so that meant that the losses were so bad in the short side of our portfolio that our long picks, which were fine, just weren’t able to offset it.
Robert Armstrong
We thought, OK, we don’t wanna be 100 per cent short in case something goes wrong. Let’s buy two nice, safe, very high-quality companies, which we did in Domino’s and Hershey’s.
Ethan Wu
Nestlé.
Robert Armstrong
Oh, I’m sorry. I was thinking American chocolate. I apologise to the nation of Switzerland for that mistake. We buy these two very safe companies. And that way if the market goes up, we’ll have some protection. That was a mistake in itself. In an expansion, it’s not high-quality, safe, defensive names like Domino’s and Nestlé that rise. It’s risky companies, right? It’s growthy companies. So these longs — Nestlé was kind of flattish, Domino’s was sort of up with the market — they didn’t really offset the damage we did with our short picks.
Ethan Wu
Yeah. So that was the anatomy of the carnage in 2023. Rob, what do you feel like we learned?
Robert Armstrong
First of all, no regrets. (Ethan laughs) It’s a stockpicking contest. You have to shoot the ball from half court if you wanna have a chance to win. And sometimes when you shoot the ball from half court, you miss.
Ethan Wu
Sometimes you’re Steph Curry though.
Robert Armstrong
Sometimes you’re Steph Curry, sometimes you miss. So I don’t regret of course packing the portfolio with risk. What I do regret is betting against companies with secular tailwinds — that’s a losing proposition — and I regret not understanding what should have been an obvious dynamic in the homebuilding industry. I don’t regret the bitcoin bet at all.
Ethan Wu
Yeah, that could have gone either way, I think.
Robert Armstrong
Yeah.
Ethan Wu
This year though.
Robert Armstrong
This is the year!
Ethan Wu
This is the year! Get your bets in on Unhedged, folks. We’re going up. Up, up, up. The inverse Unhedged ETF is gonna have a terrible year in 2024.
Robert Armstrong
OK. So now in actual stockpicking you don’t wanna make macro bets, right? It’s not smart because any insight you might have into broad trends in the market or the economy, any insight like that is gonna be a multiyear trend. It’s a coin flip whether the trend is gonna take hold in a given year. Even if you have a one-year stockpicking contest, you might have a good long-term macro thesis and you might stick with it but that’s a multiyear bet. But we’re gonna make a bet anyway. We’re gonna make a bet on a style.
Ethan Wu
Yeah. That style, it’s called Garp.
Robert Armstrong
Garp.
Ethan Wu
What is Garp?
Robert Armstrong
Which is not the movie or the John Irving . . .
Ethan Wu
It is growth at a reasonable price.
Robert Armstrong
So we don’t know what’s . . . We’re acknowledging that we don’t know what’s gonna happen in the macroeconomic environment this year so instead what we are doing is saying what style of stock is well-suited for an uncertain and volatile macro environment? Well, we like stocks that are inexpensive but have a little growth anyway. And expensive stocks, actually. Growthy, fancy, techie names have done really well for the last couple of years, so we hope that changes and value comes in a little bit. And we hope that under any circumstances, owning companies that grow some will help. So we’re giving Garp a try this year.
Ethan Wu
Giving Garp a chance. And the hope is that if you buy companies with growth potential at a reasonable valuation multiple, usually that’s going to reflect some kind of issue that they have that the market has priced in, right? There’s a reason that the growth is not trading expensive. It’s trading cheap.
Robert Armstrong
Yes.
Ethan Wu
And we tried to take, you know, in the limited time we have, take a look at these companies and say, well, maybe the worries are a little overpriced and there’s more upside here than the market’s giving them credit for. OK, Garp — growth at a reasonable price. What do you got, Rob?
Robert Armstrong
First pick: Dollar General. You put it really well. You wanna find a company that is cheap for a reason but you think the reason might go away. And this is a company that’s in a restructuring. It has a new management team. It did an acquisition a few years ago that has not gone well. It had problems with inflation during the crisis. So the stock which traditionally boasts great growth, the dollar-store model is a great growth model that has generated great returns for investors over the long term. I’m hoping the new management team can turn this thing around. Inflation becomes less of a problem. The problems from the acquisition a few years ago at Family Dollar get better and the stock goes on a rip.
Ethan Wu
Yeah. Well, another stock that we picked that might benefit from a lower inflation environment: General Dynamics.
Robert Armstrong
Yes. Well also it’s a defence stock. You may not have heard, Ethan, but the world is going to hell in a handbasket — a lot of wars. So, you know, they’re a defence and aerospace firm. You know that will help. They’re just, it’s an extremely cheap stock relative to its earnings. It’s been a slow grower but expectations, partly because of the hostile environment we’re living in this world, growth expectations for earnings are pretty good over the next couple of years. I like the idea of owning a defensive stock and that one, the expectations for growth are pretty good.
Ethan Wu
So there’s Dollar Tree, General Dynamics. One that I picked was Expedia. People might notice that they got ads everywhere. It’s one of these consumer travel companies. It’s got a pretty modest p/e ratio given how much profit growth it’s had, which is a lot. And the reason for that in part is it’s a competitive industry. There’s a lot of consumer travel companies, a lot of people that wanna sell you plane tickets and hotel tickets and so forth. What Expedia has going for it, though, is a really good cost-cutting strategy in an industry that’s growing. So they’ve been growing profit margins really substantially over the past couple of quarters. You know, if that continues, they’ve got, you know, a big digitisation push that’s working. The travel market’s not really slowing down. Recession would derail this pick for sure, but there’s not that much good news priced in for Expedia and there’s a lot that could go right on the cost side. And there’s plenty of good news to still come in the travel market assuming the economy doesn’t slow down. So that’s Expedia.
Robert Armstrong
I like it. My next pick was Everest Group, which is a reinsurer. So they are an insurance company for insurance companies. They do have a primary property casualty insurance unit, but mostly they’re reinsurance. The reason I like that stock is reinsurance companies are always cheap because in a sense it’s just capital, right? It’s like a kind of bank or a reverse bank. So it’s cheap for the same reason banks are. But it’s been a bad business for a couple of years because too much capital rushed into reinsurance and because in the last five years, we’ve had some bad catastrophic events: hurricanes. Now, prices in the industry have gone up because of those hurricanes. Whenever there’s a bad event, what happens is the insurance companies take a whipping and then repricing season comes and they go to their customers and they say, remember that hurricane last year? We gotta raise our prices. So pricing is firm. Capital has left the industry so it’s a little bit less competitive. And because I control the weather with my mind, I know there aren’t gonna be any hurricanes this year. So between those three factors, I think we’re in very good shape with that one.
Ethan Wu
We’re short hurricanes. Yeah.
Robert Armstrong
(Laughter) Basically we’re short hurricanes.
Ethan Wu
Yeah. OK. Pick five, and this is one that’s already been kind of paying some dividends for us: Cigna, the health insurer.
Robert Armstrong
Cigna — very boring company. They basically are a commercial health insurer in the United States. You work for a big company. It’s like UnitedHealth or Cigna is probably one of your insurers. It’s a good growth business because basically healthcare prices go up and health insurance premiums are, you know, grow with healthcare costs. And Cigna is the cheapest of the group. It’s the cheapest of the group however, interestingly, because it is not involved in government health insurance. It’s not involved in Medicare Advantage.
Ethan Wu
Right. And so these are plans that, they’re determined both by the government and the private market.
Robert Armstrong
And the private market. And Cigna has been small in that business compared to competitors. That business have been growing well but it’s not having a good year this year. So while its competitors will be suffering a little bit because the Medicare Advantage business isn’t doing that great, suddenly Cigna’s lack of that business looks like a virtue. And the stock’s been up so far this year. Fingers firmly crossed. Very cheap stock, some earnings growth. And in the case where it’s a bit choppy out there in markets a reinsurer, a health insurer, a defence company, I think these are gonna do pretty well. And in a more lively market, an up market, a good economy, I think Expedia is gonna, could do really well.
Ethan Wu
Yeah, absolutely. So there you have it. Everest Group, Cigna, Dollar Tree, General Dynamics and Expedia. These are our Garp picks for 2024. Now you’ll notice none of them are to the moon, crypto-grotesque . . .
Robert Armstrong
Yeah, that’s what I’m worried about. That’s what I’m worried about, is that this portfolio, maybe we were scared because of last year’s disaster, but what I’m worried about is we don’t have enough risk in the portfolio. Maybe we were too timid because we took big, risky bets last year. We got completely smoked. And this year, do we have the stuff in the portfolio that wins a stock picking contest? Like, I wouldn’t mind owning this portfolio in my actual portfolio. And that suggests to me that it can’t possibly win a stockpicking contest. It’s gonna be a very specific set of circumstances in which this portfolio wins. And it will be there’s a strong shift from growth stocks to value stocks in terms of investor preferences. And probably the economy has a slowing pattern in the second half of the year. We’re not seeing that now, but those are the two things where I think we might do pretty well in the contest.
Ethan Wu
All right. Growth at a reasonable price. Listeners, if you have happened to enter the FT 2024 stockpicking contest, please email us. Let us know what you picked. ethan.wu@ft.com.
Robert Armstrong
OK. And let us say together at the end here, this is not investing advice.
Ethan Wu
Not investing advice.
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Robert Armstrong
Past performance, as I often tell my wife, is not predictive of future performance.
Ethan Wu
In this case, a good thing.
Robert Armstrong
A good thing!
Ethan Wu
In this case, a good thing. All right, Rob, we’ll be back in a moment with Long/Short.
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Welcome back. This is Long/Short, that part of the show where we go long a thing we love, short a thing we hate. Rob, I’m long Disney.
Robert Armstrong
Whoa!
Ethan Wu
We’ve talked about on the show their problems with activist investors, the slumping stock, the streaming losses, etc, etc.
Robert Armstrong
Everyone’s bored of Marvel movies.
Ethan Wu
Everyone hates Marvel movies. But they just had an earnings call yesterday. Bob Iger came to play. He came with like seven announcements of new stuff that Disney’s doing. They’ve got a partnership with Fortnite, exclusive streaming rights to a Taylor Swift movie, their buyback dividend, all this crazy stuff and they’re reducing the streaming losses.
Robert Armstrong
Yeah, that’s the real story with Disney, right, the streaming losses. And they get those under control, it’s a different company.
Ethan Wu
I mean Iger’s come around in kind of record time, started engineering some kind of turnaround. Obviously, we’ll see, you know, how it eventually turns out. Did the stock like the earnings call yesterday? I’m feeling good about. I’m long Disney.
Robert Armstrong
Right on. Too bad we don’t have another stock pick.
Ethan Wu
Yeah. (Laughter) We should have gone long Disney.
Robert Armstrong
OK, Ethan, I am short the final stage of “enshittification”. And I use that word because it was in the FT today. The tech critic and gadfly Cory Doctorow had a piece in our paper today called “‘Enshittification’ is coming for absolutely everything”. And this is a process, enshittification, in which social networks inevitably become terrible. And he says here it’s a three-stage process. First, platforms are good to their users — Twitter or Facebook, whatever. Then they abuse their users to make things better for their business customers. Finally, they abuse their business customers to claw back all the value for themselves. Then he says there is a fourth stage. The networks die. I think the networks never die. I think enshittification can go on forever. The network effects are so strong that it doesn’t matter. Twitter has gotten way worse. Doesn’t matter, we all still use it. However bad the social networks get, they will continue to be good businesses.
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Ethan Wu
Infinite enshittification.
Robert Armstrong
I’m long that.
Ethan Wu
You’re long infinite enshittification. All right Rob, thanks for being here. We’ll have you back soon. And listeners, we’re back in your feed on Tuesday with another episode of Unhedged. Catch you then.
Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie, Gretta Cohn and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com/unhedgedoffer. I’m Ethan Wu. Thanks for listening.
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