Learning the right lessons (from 2022)

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When we look back on this year, as every year, we have things we can and should learn. But let me submit for your consideration that there are some very tempting lessons that we should NOT learn from this year. Learning the wrong lessons will lead us astray. But it’s been such a painful year, it seems the only thing that would have “worked” would have been to NOT invest. Personally it’s been harder than ever to fight against that conclusion (which I know is false long term, and isn’t viable anyway) and to try to learn the right lessons. Here are some examples.

2022 observation #1: There are bad periods to invest in stocks.
In fact, it wasn’t just stocks. This was just a bad year to invest in most anything. Sure a few things did well: Oil stocks, some health care, a few other cyclicals like Caterpillar. But in general it was awful everywhere. And this isn’t a revelation. We all know that the stock market goes down sometimes. But this year we were reminded how it feels. And if we live long enough the market will remind us again – could even be in 2023! (I hope not)

Good lesson: I have to be prepared for this to happen at any point. For retired folks maybe that means taking some money out of the market in boom times, like Saul has mentioned doing more than once. For those still working, it probably means getting comfortable with portfolio setbacks, and knowing that if you continue to buy over time you’ll get money in at the highs but also at the lows.

Wrong lesson: “We should have seen this coming somehow and gone into oil stocks, or hidden our money under the mattress this year.” Looking back, this would have been a genius move. And a few people probably guessed right on some things to some extent. But that’s what these are: guesses. And what’s the guess now? Get back in? Wait until the market starts to go up and miss 25% of it? What looks clear in retrospect was never clear at the time.

2022 observation #2: Inflation and Interest rates make a huge difference.

Good lesson: Wow, macro is powerful. Inflation alone can lead to the series of events that we’ve seen this year (exacerbated by other things like war), and crush the market. …And in other times it can be a scary “thing” that doesn’t actually show up (sometimes like recently, for 40 years). We don’t know which time we’re living in until after it happens.

Wrong lesson: “We need to pay more attention to macro and try to react to it.” Look, I think we always need to be nimble. Heck, I’m holding more cash in the portfolio than usual. But not because I think I can time the market. It’s partially for mental health and security, and it’s partially because of a lack of companies that I love right now. If we try to become macro analysts, my belief is, we’ll drive ourselves crazy and we will find more false positives than actual positives. Because the entire time I’ve been investing, even the most boom times, there has never been a time when there’s nothing we can find to worry about. (hat tip to Peter Lynch for that thought)

2022 observation #3: SaaS was absolutely demolished this year.

Good lesson: There are no magic beans. Sure, SaaS is a fantastic business model, but it’s not a panacea. We knew everything got ahead of itself in 2021. Now valuations have swung back down. Also, the companies aren’t doing as well in this economy as they have in past years. But all the great things about SaaS still exist. Great gross margins, easy path to profitability if managed well, NRR, land and expand…and most importantly subscriptions which mean not having to start from scratch every quarter.

Wrong lesson: “We picked the wrong stocks.” I just don’t buy that. At all. Freaking Google (Alphabet) is down almost 40% this year. Amazon is down 50%. Facebook (Meta) and Tesla are down more than Datadog, BILL, or Snowflake. I’m not just picking random companies – at the start of 2022, those four giants and Apple and Microsoft (also both down 25-30% this year) were the top 6 companies in the world. When the world’s largest companies can fall 50%+…a couple of them close to 70%…I don’t know that I’ve ever seen that in a single year. Maybe the big banks in 2008, but not companies like these that are for the most part doing business as usual. I don’t follow too closely, but I’m pretty sure these companies are fine (certainly Amazon for crying out loud), and I’m very confident our companies are too. It has just been a combination of starting from a valuation mountaintop, and then a year of Murphy’s law.

Concluding thoughts
It’s difficult to believe the “right” lessons, and to reject the “wrong” lessons. That’s one reason I wanted to type them out. I’m as guilty as anyone of being dejected lately, and of reacting – the impulse is to withdraw and go hide. But reflection reminds me: surviving down markets is integral to being an investor: we just have to have a plan that includes being prepared for these times.

Any thoughts? What other observations or reminders has 2022 brought? And what’s the right lesson to learn?

Thanks,
Bear

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Thank you for the excellent take-always and well-articulated post, Bear.

What has been the most helpful for me most during the 2022 character-building opportunity has been to look at the graphic that shows the historical stock market returns.

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What has helped ground my expectations and give me the required intestinal fortitude to stay invested during down years has been to look at this graphic of historical stock market performance and to remember ahead of time that there will

  1. be up years and down years
  2. be more up years than down years
  3. Since the late 1870s, the market has continued to go (grow) up and to the right

The last 12 months have proven that we got spoiled with growth during the last decade plus. Although we all hoped it would not be the case, even our SaaS companies proved they too are not immune to the macro dynamics of inflation, interest rates and wars that have fueled the massive and unprecedented value fluctuations in 2022. Our highs are higher with SaaS companies and the lows are lower than with companies who sell “stuff” rather than software subscriptions.

More than once this year, I have pondered Benjamin Graham’s quote that in the short term, the stock market is a voting machine (market sentiment of fear and greed), and in the long term the stock market is a weighing machine (based on company performance/fundamentals). Graham’s quote has been a reminder for me, of the sort of self-talk I’ve used to keep my own investing mindset in check.

Market sentiment, aka the market’s fear in reaction the current inflation, interest rates and war in Ukraine are the voting machine that has caused the short-term valuations of our companies to decline. At the risk of sounding like Captain Obvious, I personally believe the weighing machine of fundamental performance will not fail us in the long term.

During the last 6 or so years, my portfolio has been allocated to stocks in companies that followed Saul’s approach. Prior to investing in SaaS-based companies, back when most of us on Saul’s board were investing in companies that sold “things” such as comfort shoes, athletic clothing, a home builder, etc., the returns were great, yet once SaaS came into play returns improved significantly mainly due to their revenue growth and margins.

Perhaps SaaS valuations got out ahead of their skis in 2021, yet I anticipate most of the companies included in our individual portfolios will come back to their highs of the past, given the earnings of SaaS companies that rely on software subscriptions in comparison to more traditional companies that sell “things.” My personal opinion and expectation for the future is that following this approach will continue to result in higher highs and lower lows. I continually remind myself that volatility does not equal risk, rather volatility is a requirement…a ticket required to enter the stadium where this style of investing takes place.

Although research, preparation and behavioral mindset are both important, during previous short-term downturns, I’ve been mindful to use the +/- 30% corrections to develop and train my mindset/behavioral fortitude, knowing that the behavioral component of investing outweighs the importance of research and preparation.

All this said, it confirms what many of us have heard. 95% of people should stick with investing in index mutual funds. As difficult as this last year has been, it also has been an opportunity to train and reinforce one’s behavioral mindset. If we can get through investing in 2022, we can hopefully get through anything.

Each of us forms opinions based on the most current information that’s available to us. These are mine, and they are simply that. My opinions.

May we all be fortunate to make the best decisions we can in 2023 and beyond. Thank you to Saul for sharing the gift of your knowledge, wisdom and opinions, and to everyone who does the same to make Saul’s discussion board the treasure trove that it has become.

sjo

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Good post, Bear. I think it is always important to reflect on the key lessons learned so we can avoid making the same mistakes down the road.

You touched on it in your post but for me, one of the big takeaways from 2022 is understanding the importance of valuations and how they impact future CAGR. Over the last couple years, there was so much liquidity in the market that prices soared for all kinds of ‘assets’ - stocks, cryptocurrencies, SPACs, real estate and even NFT’s.

SaaS valuations specifically got well ahead of themselves and I will be the first to admit I did not pay as much attention to this as I should have. I tried to tell myself this was the new norm for these types of high growth SaaS stocks in the age of digital transformation but the reality is they were propped up by the amount of liquidity coupled with the pull forward from the pandemic.

The graph below from Jamin Ball’s Clouded Judgement illustrates this quite well. I focus more on the blue line because we generally invest in high growth businesses. Multiples for this cohort were elevated well above 25x forward sales for the vast majority of 2020-21. In hindsight, I think this kind of valuation is very unreasonable, even for the best growth stocks.

image

To your point, inflation and interest rates make a huge difference and in this instance, the near zero interest rates and massive QE led high growth SaaS stocks to insane valuations. Obviously, this year we have seen the exact opposite and consequently, the pendulum has swung hard back the other direction but my point is, I don’t think we should expect a strong CAGR when purchasing a business trading 30x NTM sales. Personally, I would be surprised if we see these kind of multiples again anytime soon.

Today, I believe we have overshot (once again) on the downside and I now expect valuations to expand as the macro environment improves. But the big learning for me this year is you cannot purchase a stock at any price and expect a good return, or in other words, the price you pay matters. This may be an extremely simple observation and very obvious to most here but I confess I got swept up in good times and thought they would keep on going.

Rex

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I agree with both of these–valuations are important and while SaaS companies have very resilient business models, their revenue growth isn’t immune from tough economic times.

To illustrate both of those points, I’ve posted 2 scatterplots below showing the 3-month average price over last 12 month’s FCF vs analyst estimates for next 12 month revenue growth. The top chart shows companies based on Oct-Dec 2021 metrics, while the bottom chart shows the same metrics for Oct-Deb 2022. (I maintained the x and y-axes on the same scale and removed some extreme outliers in both).

The compression for the valuation and growth of SaaS companies over the past year is visually quite stark–you can see huge movement to the bottom left of the chart. 30% growth now earns ~50x Price/FCF multiple compared to ~120x a year ago. Further, most companies are now in the 5-20% growth range and others like CRWD have decelerated from 55% expected growth to around 35% expected growth.

All that being said, I’m hopeful that the macro environment steadies at some point and these lower valuations set us up to receive the lion’s share of growth as price appreciation over the next few years. To give an example, I mentioned CRWD in the previous paragraph because there seems to be a lot of skepticism about continuing to hold them with decelerating growth. While CRWD is projected to “only” grow 35% next year, they’re being “priced” as if they’re going to grow 25% at today’s valuations and 12%(!) at last year’s levels. I think in hindsight there’s much less risk investing in these companies today than there was 12 months ago.

And so I think my key takeaway is that investing in the best companies will win over the medium to long-term, but as a person who’s still working to earn an income and can steadily invest over time, I’ll try to be a bit more careful of when I’m investing new income into companies. I know this is a form of timing the market–I’ll always be mostly to fully invested–but if valuations become severely stretched again, I can hopefully have more patience and keep additional dry powder to be better prepared for a situation like 2022.

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Hi Bear,

Thanks for this excellent, honest summary of your learnings from this year.

Investing in 2022 was really brutal.

And while we cannot control macro and market sentiment, we can control our sentiment as well as our portfolio choices: Owning the best companies we can find out there.

Your point about some well-established companies, that were beaten down just as badly or worse, really resonated with me. It puts some things into perspective, especially since SaaS and SaaS investing is being criticized harshly by many these days and it is easy to draw the wrong conclusions out of these short-term developments, as you said.

Here are some of my learnings in a nutshell:

  • Focus on what you can control. There is no added value in obsessing over what’s not in our hands. I feel better off focusing on what I can control and act accordingly, like putting the energy into analyzing our companies and making decisions that make me feel good about my portfolios.

  • Be prepared for the unprepared. If the past 3 years taught me anything, it is that we cannot predict anything. Covid? The war and energy crisis in Europe? Inflation? While we can certainly have expectations about the future, like, how the IT budgets might develop, what the fed might do, there is just no way of predicting anything. Or, timing the market (every time I thought I bought at the bottom, the market proofed me wrong).

  • I cannot half-heartedly run a concentrated portfolio. I increasingly transitioned my portfolio into a very concentrated one over the past 2 years. And sometimes, I did not put in as much time into keeping up-to-date with my companies as I should have. This feels okay-ish (note to self: it shouldn’t) in happy market times, but gets really dangerous in times like these. To maintain this investment style, I need to feel good about my portfolio in good and bad times, so I will not let my company review practice slip again.

  • Don’t forget the long-term perspective. Piggybacking off Sjo’s comment, it is easy to get hung up in the nitty gritty of the present. Especially when the present feels disastrous. But it helps to zoom out and think about the next 5 years, 10 years or even more.

  • FOMO and fear are the worst advisors. I am not hasty anymore about my portfolio decisions. I don’t shift money without taking the time I need to think it through, and I won’t buy anything out of FOMO anymore. What counts is to be invested into the best companies. Making portfolio changes a bit later or earlier doesn’t move the needle – at least not in the big picture.

  • Get the basics right. This is more important in times like these than ever. With basics, I mean things like not investing money one might need, choose an investing style that feels comfortable and can be maintained in tough times, etc.

May 2023 be a better year for us than 2022!

Until then, let’s not stick our heads into the sand.

ostrich approach

Best,

Lisa

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Awesome and brilliant post Bear. I would add that the right lesson to learn is to be patient, respect yourself and your efforts and to realize that we are honestly in the midst of the greatest technological change in the entire history of human communication. The amount of information, data, opinions combined with amplification of emotions warps our sense of time. The investor who can check in with stocks and read countless pages of information EVERY SINGLE DAY has a different relation with time itself than investors from a short while ago. So the point is as we wait for the stories of Snowflake, Cloudflare, Data Dog, etc. to play out a day, a week, a month, a YEAR!, two years FEELS like an eternity. Intellectually we know that 2 or 3, even 5 years is not a huge deal in the decades long stories of stocks. But it feels like forever.

So I would say the right lesson to learn here is that our relationship to time has changed. And what we are trying to do is very difficult in this environment. So be patient, kind, forgiving as well as tenacious, resilient and above all as my pal Stock Novice says - STICK TO THE PROCESS, stick to the criteria, make rational decisions and play the long game. The dignity, humility, toughness this board, overall, has shown in the face of this disastrous year has been a great inspiration and we must never forget the human-ness of our community. The value of money is vital, but the value of time, of feeling part of something bigger, that is dignified is equally important. From that point of view, this year has been an extraordinary success. I’m grateful for you all and this is more true than ever. We are being tested. And the board is passing with flying colors. And we will win in the end.

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I understand that regressing valuations were a huge part of the down year, but valuations always fluctuate, and it’s important to remember that it was the market writ large, not just our stocks.

Good lessons: Trim a little when things are high. Put money aside that you might want in the next few years. Don’t maybe add to positions as much. Be more skeptical when starting new positions. Maybe even hold a cash position rather than “forcing it” into something you don’t feel great about.

Wrong lesson: Obsess over valuation so much that you try to time the market and miss the boom times. “Best” case you just don’t participate in the market half the time. Worst case, you get FOMO in the heat of bull market and “get in” just in time for the crash.

As Lisa points out, we need to focus on what we can control. The most important thing is picking the best companies. That will always be true.

Bear

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I want to emphasize what Bear said here. I feel it’s really important, when you trim because prices are high, to put some money aside out of the market permanently, not money you are waiting to put it back in if the market goes down a little.

It’s a little less urgent if you are young, with a good job, and money coming in regularly, but if you are older, or retired as many of us are, it’s crucial to have money set aside, never-to-be-invested money no matter how low the market goes, but safety and security money to live on for a while, so you don’t ever have to sell at the bottom and so that you can feel secure.

Saul

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Wow, great thread! I’m not going to have much in my portfolio summary. Maybe it’ll just be about the companies😂

‘Success in the Stock Market has more to do with temperament than how smart you are’, often stated by Charlie Munger and Warren Buffett.

From what I’ve gathered here over the years, the best suggestions in how to facilitate this temperament includes: sharing here while following the rules of the Board, thinking in percentages, moving decimal places to the left, and above all maintaining a focus on company performance and not share-price/valuation.

Happy New year! Yes we’ve been through some existential uncertainty. Too many have paid the ultimate price (COVID,Ukraine). How could re-inflation near the end of a global pandemic and then Russia invading Ukraine not effect everything. Getting Macro out of the way, I just don’t believe we have any option to investing for the future. When Mr Market moves back toward Risk On, and the Market becomes a weighing machine again, the companies in this portfolio are the sure leaders, IMHumbleO.

Where we Started This Year:

This portfolio is what is in our non-taxable Roth and Rollover IRAs. My goal for my personal investing has always been to be able to travel extensively throughout retirement and donate an amount equal to our total expenses. This portfolio is what will enable us to continue contributing to the world throughout our retirement, as we travel. My wife and I plan to retire within the next three years

My wife is a Kinder Teacher and I’m a Physical Therapist. Neither my 401k nor her 403B has a self directed option. If I lost everything in the above portfolio we would still have a retirement well above the US poverty line. I am 55 and my wife is 53.

We have a son. He turned 16 this month. Without a plan of when to cash out his investments, he’s no longer getting a car when he turns 16 this month. He did learn to delay gratification; but, without an exit strategy, he’s facing a tough choice now. He received money for his excellent grades in school and invested that into a brokerage account, beginning when he was 6. Instead of buying that black Model 3 for his birthday this month, he’s begrudgingly decided to forego the $250 deposit and leave the money in the market in order to try for an exit window ten months from now. His plan now is to help pay for his attendance at a Tennis Academy in Biot, France, for his Junior year in High School.

Perhaps unsurprisingly, like my son’s lack of an exit strategy, I had no ‘real plan’ for my retirement. I could have taken out what I needed last December. At that time, I had enough to take out 3 years of expenses:donations (2 and 1/2 years ahead of our planned retirement date). Unfortunately, I’d had a dollar amount in my mind that was ‘just a little bit more’. I could have followed the advice, ‘don’t invest any money I’m not willing to leave invested for at least three years’. I knew this bit of wisdom. Instead, I left it all in.

What Now:

Now, we’re down ~60%, from where we were at the beginning of this year. We’re still planning to retire in 2.5 years, despite this massive pull back in share prices. It’s just that now, instead of having the luxury of taking out enough cash for 3 Years of expenses:donations, I’ll be lucky to be able to take out 2. And that’ll only happen if we manage to get positive returns this next couple of years. And then if that all goes well, I’ll be taking that amount out only a year before our planned retirement date. But at least it’s some kind of a plan😂.

I know, planning to take out the cash only one year a head of time is cutting it close. But, I really do feel like we’re now at a multi-year bottom. If I’m wrong, I still enjoy being a Physical Therapist and I am currently willing and able to work 5, even 10 more years if needed.

========

What I Learned This Year

Maybe I didn’t take any money out last December because I allowed myself to be conditioned to believe any pull back would be short in duration. I knew I should not leave any money invested I might need in the next three years. Likely, I was just letting my ego take over too much control of our finances. Luckily, my general temperament (how well I manage my emotions) kept me from making worse mistakes.

At the beginning of the year, I was convinced that these companies would weather any storm. I was focused more on how each company would most surprise Mr Market to the upside and therefore achieve outsized share price gains. I still do that; but in order to manage my emotions, in addition to those recommendations I gathered here and listed at the top on this summary, over the course of this year I’ve moved my focus a little more towards share count. Making this subtle adjustment has added to my feeling a bit more certain during uncertain times (improved my temperament).

The changes I’ve intentionally made over this last year, in the portfolio here, seem about right to me (Is this in part based on confirmation bias? Perhaps.) I do now have at least twice the confidence I did in Snowflake, compared to a year ago, and I feel my other decisions were likewise made. The point I mean to make is that, due in part to this years ‘reset’ in share prices, I’m better positioned now, compared to any time in the past, to reach my goal for investing. I do now, compared to the begining of this year, have 2x the number of shares I had in Snowflake, 2x the number of shares in Cloudflare , 10% more shares in Datadog and having sold ZoomInfo and what was left of Upstart and with that I acquired a ~14% position in Bill. Some things that improve your emotions/temperament during a year like this, may seem silly; but after this last year, I agree they may be essential, for long term successes.

Success in the Stock Market has more to do with temperament than how smart you are., as I’ve heard being often stated by Charlie Munger and Warren Buffett.

Currently, I do I feel wiser from the experience of seeing first hand how these companies perform given the culmination of multiple Macro headwinds. The tide has gone out and I wasn’t swimming naked. I have significantly more shares now, in the companies I have the most confidence.

Keeping this in mind helps me feel calm and more sure of the future. But, will the actual company performance ever outshine (via increasing share price) this last years share price implosion? I say yes, so I’m all in as per usual.

I’m most proud of my not trying to place time pressure on an outcome, when the determinants are not all within my influence (Is this due in part to circular reasoning? I don’t believe so.).

Thanks

I give most of the credit for my maintaining confidence throughout the experience of this last year to the clarity of Saul’s reasoning here.

Saul has said, “There is no formulae for investing…it’s too complicated” and most here recommend, “Read Saul’s Knowledge Base and his Recommended Posts.” I agree with this and also that the advantages the individual investor has are multiples greater when crowdsourcing information with like minded people, such as yourself. Given the experience of this last year, I’m sure that when I do retire from working a steady day job, I’ll have the needed wisdom/temperament to weather future down-turns with even greater confidence😊.

For the opportunity to participate here, thanks is not adequate,

As always you all have only my very best wishes,

Jason

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