Lessons For Us From Ron Baron Quarterly Letter

This may veer into OT territory, but in times like these I think it’s vital that we act with a clear head and long term perspective. I think this perspective, from growth investor Ron Baron, from their 1st quarter shareholder letter, is a great reminder of the game we are playing, the current environment and the long term vision we all share. BTW, the fund owns many of the names owned by all of us.

Credit to my friend Vijay, who posted this in a chat room that we participate, and I thought it was important enough to share here.

https://seekingalpha.com/article/4507886-baron-global-advant…

The parts that particularly resonated with me are:

"A commodity cycle driven by rapidly rising inflation, the regulatory crackdown in China, and the geopolitical crisis culminating with Russia’s invasion of Ukraine led to a dramatic shift in investors’ risk tolerance and time horizons. As a strategy focused on Big Ideas, we tend to do well when investors are confident in the present and optimistic about the future. By definition, companies we invest in for this Fund believe they are creating or addressing huge markets in a unique, innovative, and often disruptive way with a very long runway for growth. Because they believe their growth to be especially durable, they overinvest and underearn today forcing investors to value them on cash flows that will be generated in the future. When investors lose confidence in the present, the future suddenly becomes more uncertain and less relevant, and the current free cash flow yield turns into the dominant valuation metric of choice. As Jeff Bezos and his shareholders found out in 2000, that is a tough environment to be overinvesting and underearning in. But stock prices aside (just for a moment), the fundamentals of many of our businesses resemble and “sound” just like Amazon did over 20 years ago.

Benjamin Graham famously said that “in the short run, the market is a voting machine but in the long run, it is a weighing machine.” In his 2000 letter to shareholders, Jeff Bezos wrote that Amazon is a “company that wants to be weighed, and over time we will be - over the long term, all companies are. In the meantime, we have our heads down working to build a heavier and heavier company.” That too resonates with us. Cycles will come and go. The booms, and the inevitable busts. At some point, the focus will shift from the “here and now” to what will this look like when the dust settles, and the clouds dissipate? We have never been concerned with the market’s voting and have tried to caution our investors against giving too much weight to our short- term returns, especially when they were impressive. Instead, we focus on optimizing for the long-term cumulative weight of our businesses. Investing in unique, competitively advantaged businesses with long duration of growth and strong unit economics that enable rising returns on invested capital is the most proven way we know of getting it done.

Back to the “Ouch!” quarter. Despite the brutal headline numbers, we believe we have actually done a much better job from the capital preservation perspective than those numbers suggest. While 52 out of our 58 holdings saw their stock prices decline during the quarter, we have a high degree of confidence that the overwhelming majority of these businesses did NOT suffer permanent impairments and that the intrinsic values of many of them are actually higher today than they were at the end of last year. The stock prices were down largely due to multiple contractions as the negative macro environment shortened investors’ time horizon causing long-duration assets (i.e., Big Ideas) to get hit the hardest. We have no idea how long the current “voting” environment will remain or when the proverbial bottom will be hit, but we have a lot of conviction that over the next decade, companies across industries will continue shifting workloads to the cloud, adopt zero-trust cybersecurity architectures, and continue to digitally transform. Penetration of e-commerce will continue to rise, and DNA sequencing and the use of genomics and proteomics will become pervasive in personalized medicine. Electric vehicles, autonomous, shared mobility will disrupt transportation. Better decision making across every sector of the economy will be driven by the analysis and usage of actual, real-time data. These dynamics will enable the companies driving these trends to compound their intrinsic values and to “accumulate weight,” which over time will be reflected in their stock prices."

63 Likes

Again,

Thank you for this perspective. I heard you left I/O fund. This has been a painful cycle. I ate a lot of humble pie but I learned a lot as well. As always, I try to keep my core holdings and not sell. Sometimes, the noise gets you.

AyV

1 Like

“As Jeff Bezos and his shareholders found out in 2000, that is a tough environment to be overinvesting and underearning in. But stock prices aside (just for a moment), the fundamentals of many of our businesses resemble and “sound” just like Amazon did over 20 years ago.”
https://seekingalpha.com/article/4507886-baron-global-advant…

Amazon circa 2000 is a relevant example of just how brutal the decline was for a highly successful growth stock that was ‘exuberantly’ priced in 1999: 95% drop in share price from 1999 high to 2001 low, while the company was executing great and growing gangbusters most of that time.

Just for comparison, NET is down 70% from its high so far, but trading at ~29 times trailing earnings and losing money, there’s no compelling floor in place from a valuation perspective that I can see. To match AMZN’s total decline, it would have to lose another 83% from here.

Not that I’m predicting that will happen, but AMZN is a real example of what has happened in the not so distant past with a company that did eventually live up to the hype, and more, but not before its stock price cratered far lower than most of its early investors imagined it could.

19 Likes

@Kibo and @Vijay…This was a great article and very helpful to figure out possible next steps.

The question it begs for each of our holdings is…

Can company A succeed in the long run, given current conditions?

In order to answer this question, for each of our companies, we need to look past just growth rates, however attractive they seem.

We need to look more closely at balance sheet health (debt, equity, cash on hand etc), operating expense trends (SGA, R&D, stock comp etc.) and cashflows (operating cash flow, free cash flow etc.).

The IPO market has dried up. Venture capital is holding back or being very, very selective. Hedge funds have been exiting markets in $Bs for the short term. Bond holders are hurting big time and will expect higher yields for any corporate debt or more equity for convertible debt or both.

Every single one of our companies needs to raise funds to operate…they issue debt, shares etc. As this funds raising becomes expensive, it starts hurting the bottom line and takes $ away from product development, new market entries, human capital and other growth opportunities.

Any company that cannot meet these tough market conditions will either slow down or die a natural death on the vine.

We have to be super-selective in 2022-2023.

14 Likes

Every single one of our companies needs to raise funds to operate…they issue debt, shares etc. A<\i>

Most of companies have years of cash for operations.

8 Likes

Great article
Thanks for posting
But can you clarify- is the author actually Ron Barron ?

@MFChips

Most of companies have years of cash for operations.

Almost all companies borrow money in the capital markets and use those funds to partially pay for their operating expenses/growth/acquisitions etc. If you see any debt in the liabilities section of the balance sheet, that means the company has borrowed money.

Last I checked (early April), MNDY, BRZE, AMPL were the only ones that did not have any debt. That could have changed recently.

1 Like

Most of these companies have raised debt in the form of convertible notes because it was convenient to do so: near-zero interest rates coupled with historically high stock prices. They did this to build up funds that would be more difficult to raise in different market conditions. What I’m saying is that most of these companies did not have to raise debt, they already had plenty of cash on the balance sheet and very high gross margins to dedicate entirely to investments in growth (R&D, S&M etc.). However, they decided to raise convertible debt as part of an efficient corporate finance strategy.

19 Likes

High growth companies that borrowed money in the last couple of years mostly look pretty smart to me. They did it with equity (stock prices are much lower now) or debt (interest rates are higher now) For some it was nearly free money. Taking advantage of unusually favorable government and economic policies while they were available. It may be a long time before we see such easy money again.

12 Likes

Yea Mauser,

This is the point I wanted to make. Why at the interest rates that were being offered, why wouldn’t you take the money.
We certainly did when the government was offering us loans at 2% interest rates this past year. It would have been irresponsible not to accept the loans. We are using that money to improve and update all locations, which will only increase our business. It already has. 2021 was our best year, and so far 2022 is ahead of that pace, as April has been our best month in our 24 year history.

TMB

5 Likes

This is the point I wanted to make. Why at the interest rates that were being offered, why wouldn’t you take the money.

Companies that did secondaries instead of borrowing were even smarter because they don’t have debt to repay. The secondaries at sky high prices provide very sturdy balance sheets with no worries about future cash management.

Denny Schlesinger

12 Likes

Denny,
a secondary is always bad for shareholders, no matter how high the stock price was!

please stick to the facts about debts vs secondary/dilution!

1 Like

a secondary is always bad for shareholders,

So we disagree.

please stick to the facts about debts vs secondary/dilution!

Was that really necessary?

Denny Schlesinger

15 Likes

The author is Alex Umansky, portfolio manager of Baron Global Advantage Fund

https://www.baronfunds.com/investment-insights

1 Like