Old story from August 22 2024
t’s Too Soon to Sell Nvidia, Says This Investor. Why She Likes GM and IAC Stock.
Samantha McLemore of Patient Capital sees plenty of value in the Magnificent Seven, and in small-caps and energy shares.
By Reshma Kapadia
Aug. 22, 2024 1:00 am ET
Samantha McLemore recently did something she hasn’t done in a long time: She attended a value-investing conference.
In the age of the Magnificent Seven—a group of high-price technology stocks that has propelled the stock market to new heights—value-investing gatherings, and value investors, have become harder to find. Yet McLemore, the founder and chief investment officer of Patient Capital Management, remains a member of that club, with a penchant for undervalued and unloved stocks that deserve more attention.
McLemore began her investing career in 2002 working for the legendary value investor Bill Miller. Over time, the pair refined their approach to focus on classically cheap stocks and “quality compounders”—companies whose growth prospects were underappreciated by the market. McLemore and Miller co-managed the Miller Value Partners Opportunity Equity strategy for many years, until she bought the strategy last year and renamed it Patient Opportunity Trust (ticker: LGOAX).
The strategy has returned an average annual 10% in the past five years,
lagging behind peers as the market charged higher. But the fund’s 30% return in the past 12 months has beaten 95% of its peer group, according to Morningstar.
Barron’s spoke with McLemore before the market’s steep selloff in early August, and again on Aug. 20, about why she likes Nvidia , General Motors , and energy stocks, and where she thinks Bitcoin is headed. An edited version of the conversations follows.
Barron’s: Is the bull market, especially the bull market in megacap tech stocks, over?
McLemore: For context, markets rise 70% of the time. We are still in a bull market, possibly the later stages of one. If we don’t have a recession, where small-cap stocks are sitting now doesn’t make sense. As the Federal Reserve cuts interest rates, smaller companies will do better and the market will broaden out. But I don’t think technology stocks will go down.
Some of the Magnificent Seven stocks are among the best companies that ever existed if you look at their dominance, competitive advantages, free-cash-flow margins, and return on capital. Alphabet , for example, is trading at a discount to the market multiple after its latest quarterly earnings. That’s astounding because it’s a great company with great comparative advantages.
What makes you confident that the artificial-intelligence boom isn’t a repeat of the late-1990s dot-com bubble—and that Nvidia isn’t this cycle’s Cisco Systems ?
We bought Nvidia when it was trading around 25 times earnings and everyone was worried about the sustainability of earnings and an earnings cliff, likening it to Cisco after the infrastructure buildout of the late 1990s. At the end of the second quarter, Nvidia was trading at 47 times earnings. Cisco peaked at 150 times earnings—and that’s not to say Nvidia will get there.
Whether Nvidia can continue to grow its earnings power will [determine the trajectory of the stock]. I don’t see much risk in the short term: Meta Platforms , Microsoft , and Alphabet are talking about continuing to grow capital spending next year as the AI data-center buildout continues. Shortages of GPUs [graphic processing units] will continue, especially with the launch of Nvidia’s new Blackwell chip later this year.
What will be a signal to sell Nvidia?
It is more valuation-based. We are always looking at scenarios. Nvidia has been crushing every quarter for a year. CEOs want to make the decision to invest more [in AI] rather than getting caught behind. I don’t see it ending soon.
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We focus on how quickly the company can grow over the long term. We aren’t assuming Nvidia sustains [current] operating profit margins of 65%, but rather, low-40%
Microsoft -like margins. [CEO] Jensen Huang’s vision is to create the platform for accelerated computing, the future of computing. Nvidia has hardware and software elements with a developer base, which should help the durability of its competitive advantage. If it earns 10% a year, it would beat the market. But it’s going to be lumpy.
Nvidia is at the forefront of the AI revolution and is capturing most of the profit pool in AI, as of now. In the short term, there are still a lot of fundamental tailwinds in technology and AI. We have to see how it plays out, but everyone is looking for those names.
Which stocks or sectors have been overlooked?
Look at General Motors , trading at four times earnings with a midteens return on capital. Paul Jacobsen, the chief financial officer, was at
Delta Air Lines as CFO. He is supercreative and started buying back stock aggressively.
People are worried about the sustainability of the internal-combustion-engine business, but it is still growing. And GM is shrinking shares outstanding by about 17% since the second quarter of 2023. If GM continues to shrink its shares at this pace for the next five years, shares outstanding would decline by 63% and earnings-per-share growth would be 22% higher even if net income is flat.
Where else are you finding opportunities?
Small-cap companies are much more sensitive to rate cuts than large-caps, as they have more floating-rate debt. Thus, they have done worse than large-caps, and expectations are much lower. A lot of the companies trade together, but some have resilient business models with a lot of potential.
We have been adding to IAC . The stock is down 25% since July 2023, despite the massive improvement in the business. IAC is run by some of the world’s best capital allocators, Barry Diller and Joey Levin, who have a great long-term record of compounding capital and doing deals that add value.
When you value IAC’s 20% stake in
MGM Resorts International and [home-improvement resource] Angi , plus cash on the balance sheet, you get a stock price that is a bit higher than the current price [at $51]. But you are getting a lot other businesses—including Dotdash Meredith and Care.com—effectively for free. The stock gets a 20% conglomerate discount. We value all the pieces at about $90 a share.
What is the market missing about IAC?
IAC is beating expectations, but smaller companies are just out of favor and it’s a complicated business. IAC bought Meredith, with brands like People and Better Homes & Gardens, at the peak in 2021. They didn’t appropriately appreciate where we were in that market cycle, and that it will take time for [the market] to get confidence in the trends in the business. But in the past year, we saw improvements: Dotdash Meredith reached operating profitability in the most recent quarter, and the digital piece of the business is growing at a low-double digit pace.
You own several travel stocks. Are you concerned about consumers pulling back on spending?
We have been [experiencing] the biggest boom in travel ever, but in many instances, the stocks haven’t reflected that. Since 2022, people have been concerned that the strength is on the verge of ending. Yet, remains strong. We see the consumer starting to weaken but expect that people will continue to prioritize travel, with most travel companies still seeing strong demand.
Supply has grown among airlines, depressing prices. We own Delta Air Lines and United Airlines Holdings , which earn the majority of the industry’s profits. It’s a better business than the market thinks: Low-cost players are losing money so they will have to cut back—and Delta and United will benefit.
What is the case for Norwegian Cruise Line Holdings ?
Norwegian beat earnings expectations on every metric and raised full-year guidance, but the stock fell because the company didn’t mention “record booked positions” as it had in every quarter until the latest one. This time, Norwegian said it had “very strong bookings” and saw no weakening in demand into 2025. But the market is extremely sensitive to any sense of deterioration—and the company’s debt load also makes it vulnerable on weaker days for the market.
Why aren’t you as worried about the debt?
Norwegian is targeting a multiple of four times debt to Ebitda [earnings before interest, taxes, depreciation, and amortization] by 2026 and hit its deleveraging goal for the year by the second quarter. It has the capacity to fully withstand a normal recession.
What other beaten-up parts of the market are drawing you in?
Healthcare has been under pressure until recently. We have added to stocks such as Biogen , Illumina , Royalty Pharma , and CVS Health , many of which are less economically sensitive in the event of a recession.
You have also warmed to energy stocks. Why?
Companies are much more disciplined in their spending, earning good returns on capital and generating significant free cash flow, which they historically hadn’t.
We are looking for companies mispriced based on where the long-term futures curve for crude is [about mid-$60s for West Texas Intermediate]. Kosmos , a deepwater exploration-and-production company with assets mostly off the coast of Africa and in the Gulf of Mexico, is mispriced at even levels below that.
Kosmos has been on a development splurge, with many of the assets going on-line in the second half of this year. Into next year, capital spending will come down, production will go up, and free cash flow will increase significantly, allowing the company to pay down debt and buy back stock. Many liquefied-natural-gas assets are coming on-line, so this is low-carbon energy with a long reserve life of 20 years. That makes Kosmos an attractive acquisition target. Shares trade around five times earnings. The company is worth 10 to 12 times earnings.
What investment risk is at the top of your list?
Geopolitics. We could have a recession, and markets wouldn’t do well. But there are plenty of examples through history, and losses are contained. Some scenarios are far more dire when we think about geopolitical risks with China and nuclear weapons.
How do you deal with these risks?
We entered into some agreements that let us hedge certain risks with derivatives such as credit default swaps to lay the groundwork if we think it becomes more important to do something [on that front].
What is your view of Bitcoin, given its volatile history?
[Crypto exchange] Coinbase Global weighed on our returns in 2021 to 2022 as Bitcoin suffered but has been one of our biggest contributors over the past year. I still think of Bitcoin as digital gold. Exchange-traded funds were a big step forward in broadening acceptance, and more companies, although still a small group, are talking about putting Bitcoin on their balance sheets.
There is also a lot of talk about currency debasement, fiscal deficits, and the demand for some way to preserve value. Gold has historically been the top choice, but there are benefits to a digital asset. If Bitcoin is increasingly seen as akin to digital gold, Bitcoin could get to values 10 times the current price. The younger generation is also much more enthusiastic about Bitcoin and crypto. [Former President Donald] Trump appealing to that group increases the likelihood that we will see more movement [in Bitcoin as a digital asset], even if he isn’t elected president.
Didn’t Bitcoin’s wild ride poke holes in the idea of it being gold-like?
No. We are in the very early-stage version of gold. We always knew it would be volatile. But volatility has come down, with each drawdown less than the prior one. To get broad adoption and central-bank usage, we need to see volatility episodes continue to decline over time.
Thanks, Samantha.
Write to Reshma Kapadia at reshma.kapadia@barrons.com >>>>>>>>>>>> |
