CWS Market Review – May 25, 2021

“I can calculate the motion of heavenly bodies, but not the madness of people.” – Isaac Newton

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Finance and Physics Envy

In this week’s issue, I’ll let you in on a little secret about finance. Finance suffers from a bad case of physics envy. The greats of physics have come up with all these cool equations that help explain the world. Finance wants in on the action.

As a result, Finance has come with its equations as well. The problem is that the equations are good but they’re not perfect, and that matters a lot in finance.

Finance would have you believe its practitioners are calm and rational. They simply follow the math. But sometimes numbers only tell you so much. I’ll give you an example. During the 1960s and early 1970s, there was a tremendous bull market in a select group of stocks that the press named the Nifty Fifty. Some classic Nifty 50 names were Coke, McDonalds, Disney, Polaroid, Eastman Kodak and IBM.

There was an odd connection to many of these stocks. They were seen as companies that promoted social harmony. It may seem somewhat naïve today but that was an important concern during the tumultuous 1960s. Think of the famous Coke ad of young people from different areas of the world singing the praises of Coca-Cola.

The Nifty 50 were considered “one decision” stocks. You just had to buy and hold on. The idea of social harmony gripped Wall Street. The valuations of the Nifty 50 soon left orbit. At one point, their collective P/E ratio was twice that of the rest of the stock market. The 1973-74 bear market was particularly hard on the Nifty 50. Bear in mind that the crash was the worst since 1929.

Here’s a look at Disney. Adjusted for splits, the stock went from 10 cents at its 1966 low to $2.50 by its 1973 high.

Interestingly, several of the Nifty 50 names have outperformed the market since 1972. So even paying a premium worked out after a long period. My point is that a non-numerical theme can take hold and override any concern about valuations.

This happened during the dot-com bubble when the concern was the first-mover advantage. Everyone, I recall being told, had to be aware of this. For example, the only reason Microsoft became the big winner wasn’t because they were good. No, it was that they were first and they made the industry standard.

This idea also goes by the name Winner-Take-All. (That was the name of a book in the 1990s, and the phrase turned up in Bill Clinton’s campaign speeches.)

The idea is that an early entrant could establish an industry standard which remains in place simply because it’s already there. It’s not better—it’s just there. I can’t tell you how many times I was told that some Internet stock was just like the QWERTY keyboard. There was even a magazine called The Industry Standard. In 2000, it sold more ad pages than any magazine in America. Unfortunately, the magazine folded in August 2001.

Here’s a good exercise. Imagine a roomful of people. I tell every person to choose a number between zero and 100. I say that I’ll give a cash prize to the person whose number is closest to two-thirds of the average of all the guesses.

Well, a smart person would assume the average of everyone’s guess is around 50. Therefore, two-third of that is around 33.

Easy? Not exactly. Everyone else is aware of the rules so they’ll say 33 as well. Now we’re caught up in a cycle of smaller guesses and still smaller two-thirds. Eventually, it will hit zero. (I believe studies of this game show the winning bid is around 15.)

This exercise highlights an important part of finance. Market participants know they’re part of the game. Their feelings play an important role in determining the price. In physics, gravity doesn’t know it’s being watched.

Again, numbers only tell you so much. You’ve probably heard stories like this. An art dealer has a painting she can’t move. It hangs on the wall day after day. She then triples the price, and it sells the next day. Even if it’s not literally true, it’s certainly believable.

Academics who have studied horse-racing bets have found that the absolute worst pony to bet on is the longshot. It’s obvious to me why. Because people want to bet on the longshot. (Duh!) It’s the same as the painting. Price becomes the issue. As a result, people over-bet on the longshot which unnaturally lowers its odds.

Does it make sense? Of course not. This isn’t rocket science. It’s much harder than that.

Stock Focus: Veeva Systems

I like to say that the only thing better than owning a monopoly is owning a near-monopoly. After all, the real thing tends to draw too much attention.

That leads to me to Veeva Systems (VEEV) of Pleasanton, CA. While Veeva isn’t technically a monopoly, it enjoys many of the advantages that a monopoly has. Veeva is a cloud-computing company that’s focused on pharmaceutical and life sciences industry applications. The company was founded in 2007 by Peter Gassner and Matt Wallach. Gassner has become a billionaire along the way and he currently serves as CEO.

What Veeva does is it helps drug companies capture clinal trial data and follow regulations while allowing their sales force to be more effective. The company has been very successful. In 2019, Veeva became the fifth software-as-a-services company to join the billion-dollar revenue club. The key is that Veeva brings the benefits of cloud computing to a single industry.

The age of Covid has been critical for Veeva. In order to run all those clinical trials, it normally involves visiting doctors and researchers. Veeva allows that to happen virtually. That places Veeva’s services in great demand. A particular strength is that Veeva helps its clients comply with government regulations.

I have to confess that watching Veeva has become somewhat entertaining because Wall Street consistently predicts that Veeva’s remarkable run is about to come to an end. Yet each quarterly earnings report easily dispels that notion.

Veeva has now beaten Wall Street’s consensus for at least the last 16 quarters in a row. (It could be even longer, but that’s as far back as my data goes.)

The next earnings report (their fiscal Q1) is due out this Thursday, May 27. For Q1, Veeva expects total revenues between $408 and $410 million and earnings between 77 and 78 cents per share. That’s unusually narrow guidance. For the entire year, Veeva sees revenues between $1.755 and $1.765 billion and earnings of $3.20 per share.

Veeva’s stock has not done particularly well compared with the overall market. The stock has lagged since October. Veeva has been ganged up on more than once by a nest of short-sellers. Their mantra has been, “Sure, Veeva’s had some impressive growth until now but the total addressable market isn’t that large.” I think that’s way off base.

Now let’s get to some truly remarkable stats. Veeva maintains gross margin in excess of 70%. That’s very impressive. Their operating margins are consistently over 25% and the company doesn’t carry any long-term debt. That’s a testament to how strong a position Veeva has in its market. Peter Gassner has referred to Veeva as having delivered what he calls “30/30” quarters, meaning 30% growth and 30% operating margins.

While I like Veeva a lot, I’m not a fan of the share price. Even if we assume the company’s optimistic forecast is correct (and it probably is), that means Veeva is currently trading around 80 times this year’s earnings estimate. That’s about five times what many other stocks go for.

I understand the need to pay for growth, but investors must keep things in perspective. Even if Veeva continues to cream estimates, the stock is still very, very pricey.

That’s why this earnings report is so important. If traders react badly, and they often do, it could knock the shares down. Personally, I’d love to see Veeva with a lot lower share price.

That’s all for now. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

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