Magic Markets Ep192: How to Build a Bull Case

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The Finance Ghost: Welcome to episode 192 of Magic Markets and thank you for joining us this week and making time for us in your very busy lives. We do appreciate it and we are going to try make it worth your while this week, or at least we think we are.

Moe and I have decided to work through how we go about building a bull case. I’m going to jump straight into some basics around why we’re talking about this and what a bull case is. And then, Moe, we’re going to come in on all the different stuff that we do in creating a bull case and what those key elements are.

We’re going to do this as two separate podcasts, still part of the normal Magic Markets stuff. Basically one this week and one next week. The idea is to cover a bull case today and a bear case next week and why we think it’s important to actually build one of each for every stock that we look at, not just in Magic Markets Premium, but in general it’s the same story when I look at stocks locally and I think about whether or not I want to buy them or sell them. I might not do it as formally as we do in Magic Markets Premium. And that’s the joy of Premium: we actually write the stuff down. But obviously this type of thinking is just incredibly helpful regardless of where the stock is based.

The biggest thing here is to try and get to a balanced view. That’s why we do the bull box and the bear box that we do in magic markets premium. That’s what we’ve called it. Or just a bull case and a bear case as it’s known in the market. And it’s really because things are grey, they’re not black and white. Very few stocks are either all bad or all good. In fact, in life, very little is either all bad or all good. We exist in the grey and investing is absolutely no different. Anything you look at is going to have good stuff and bad stuff. And what’s going to happen over time is the good will outweigh the bad or the bad will outweigh the good. This will then be compared to the expectations in the market, to the valuation, and voila, you have a share price move.

In our view, if you’re not building out a bull case and bear case in your own head, then how are you really assessing the valuation? How do you know if a multiple of 5x or 10x or 15x or 20x is rational or overpriced or underpriced? That’s why we’re going to cover it this way around. We’re going to do the bull case this week and we’re going to do a bear case next week. It really is just a very, very important thing.

What the bull case is, basically, is the good stuff. It’s the good news story and the positive aspects of the narrative. It’s the stuff we like about the business and the attributes and a very important point, before I hand over to Moe, is that we ignore the share price when we look at the bull case, because you’ve got to understand, or certainly our approach, that the bull case is specific to the company, not what the market is currently paying for the shares.

A share price might be heavily overinflated for a great company. It doesn’t make the company any less great. It just makes the investment potential maybe not as good as it should be. When we do this bull case, bear case, keep in mind that we are trying to value the business without reference to the share price. We are trying to understand what the business is doing. We’re trying to avoid that old trap in the market of the price driving the narrative.

 

Mohammed Nalla: That’s really quite an important point to land on because you’ve got to separate the valuation analysis from an analysis of the actual business. Try and contextualize bull and bear case as a very much a top down, strategic type of view in terms of how a company is doing. Some of the things you’ve touched on, for example, is that it’s not always black and white, it’s in the grey.

When we started Magic Markets Premium, I generally skew a lot more bearish, so in order to challenge my own thinking, I would look at taking the Bull Box and that’s kind of stuck. And I think, Ghost, you are a lot more bullish. We challenged you by forcing you to take the Bear Box.

That’s really what investment is about. It’s taking that objective view in terms of what the business is actually doing. I’m going to jump in with: how do I start constructing the bull case when looking at a company?

And again, everyone knows I very much start from a macro standpoint. So I look at the macro trends and I first of all say, is this a company that exists in a segment of the market or in a segment of the economy, for example, that I want to be involved in? Naturally, if it’s in a segment that’s growing or for example, there’s a mega trend behind it, that naturally predisposes you to something being in the Bull Box, arguably. Now, it’s not to say that the company is doing that job particularly well in its sub-industry. You’ve got to then look slightly deeper.

This is where I start asking: does the company have any competitive advantage or a moat? Is this company doing something fundamentally different to what other companies are doing in this space? And sometimes you might actually find if a company is doing that, it goes into the Bull Box. If it’s not doing that, that’s something that maybe goes into a Bear Box. We’ll cover that again next week.

So we’ve got macro trends, we’ve got a moat. Does the company operate with any sort of edge? And also tying into the moat point, I like to look at what is the total addressable market for a company? Is this in a segment of the market that’s growing? Is there lots of runway for growth? Because again, this would arguably start to extract some of the bullish points that you want to look at.

We indicated that we don’t look at the share price, but we do look at the company. This is where I would look at again at a headline level: is this a company that is growing revenues over time? So just at a top line, is the revenue growing? What does that revenue growth look like relative to the sector or the segment of the economy it’s playing in? Is it running ahead of its competitors or not? Obviously, if it’s running ahead, that goes into the bull box. What’s happening with margins as well? Just those two line items?

I don’t go much deeper than that at a Bull Box and a Bear Box phase. I look at what’s happening with the top line and what’s happening with margins, how much economic value can this company then extract? And then a last point, and it’s something that ties into a lot of the work that flows out of the Bull and Bear Box, is I like to look at management and this is because sometimes you have companies that are led by exceptional people, people that are redefining their industries. You actually find that that can be a bull point or can be a bear point. Certainly we’ve seen the instances where the founders are maybe too involved. There’s lots of key people risk in a business.

So when crafting a Bull Box, I like to look at management. Are they on the ball? Do they have their ears to the ground and are they a cut above what we’re seeing at their competitors? That’s how I start to frame the Bull Box. Ghost, what about you? I mean, when you’re building the Bull Box, what do you really start to focus on?

 

The Finance Ghost: Yeah, so my top-down is really basic in terms of the online research into just some stuff around how the business is doing. Look, the cool thing about the US market is a lot of the brands are known to us, right? If you’re going to do research into Nike, you don’t need to start with, oh, what does Nike do? We know what Nike does. Everyone knows what Nike does. It’s not always that easy though, because a lot of the times it’s a company that we may not have down in South Africa.

This week, for example, we did Dollar Tree. TL;DR: not good, but lots to learn from that show and that’s why we did it. And you know, there I had to go online and I had to actually go and try and find some pictures of Dollar Tree stores. You know them because you’re up in North America, but I don’t have the benefit of having been in one before. I had to go and do some research on that and understand what’s in there because you can’t form a bull case if you don’t know what the company actually does. Obviously you need to think sensibly about what this business looks like. So when I found the pictures of Dollar Tree and I had a look, I thought, hmm, that kind of looks messy, not too sure what they do. And then guess what, the more I read, the more I confirmed that view for myself.

That brings me to the primary source of building out a bull case, which is just to read the full earnings transcripts. We are super focused on that and you know, we both do it. I read them really, really carefully because there’s just so much in there, not only from the prepared comments by management, but also the questions from analysts. It’s one of the coolest things about investing in the US: you have access to these transcripts and on most systems you can actually go and read what the analysts asked the management teams. The transcripts are all there. You can’t do it in South Africa. Most of the time you will not find a recording of the analyst presentation. You’re not going to see those questions. This stuff happens behind closed doors. A select group of analysts are given access to management.

In the US I’m sure those analyst meetings are happening as well. But at least a portion of it is there for all to see in the transcript. And those questions are really helpful, not just to see where the analysts are focusing because that tells you a lot about what’s good at the company and what’s bad – obviously not pre-empting next week, but also just the tone, the tone of their questions. If it’s very congratulatory towards management, don’t make the mistake of thinking they’re just sucking up. This is the US. They’re not shy to ask a question and let management know how they really feel. We’ve seen plenty examples of that. If the analysts are all very much congrats, great quarter etc. that tells you something about market perception right now. And there’s a reason for that – it’s because the underlying business is doing well.

And then of course you’ve got to go and actually look at the numbers. You can’t just take it at face value and look at what management is saying and what the analysts are asking. You need to go and actually do the maths. We do all of that obviously in our Magic Markets Premium research. But for those who want to just go and do it themselves, and you should always be doing your own research, you don’t need to spend 100 hours doing the maths on any given company. You can really get some quick wins by going and having a look at just the basics.

What has been the annual revenue growth rate over the past few years and what is it now? Is it higher, is it lower? Are they accelerating versus where they’ve been? Or are they slowing down? What does that mean for gross margins? Are gross margins going up? Are gross margins going down? And then you go and marry that to the commentary in the transcript and see if it makes sense.

Same story on operating margin. Is it going up? Is it going down? What does that mean for expenses?

In a bull case, you’re looking for the good stuff. You’re not looking for everything because you’re going to do that when you do bull and bear together. And you’ll make notes in both, I guess, as you read. But from a bull case perspective, you’re looking for cool stuff around revenue trends, acceleration in that, growing faster than they have been, what are their margins doing, etc. and you’ve got to dig into the financials to actually find that stuff.

 

Mohammed Nalla: I’ll probably be a little less flattering to the analyst comments and Q&A. I think we’ve seen so many transcripts where the analysts are really just quite flattering to management, and we’ve come out with a slightly different assessment that’s then proven to be correct. In that instance, I always say, apply the same kind of logic to it is it’s never black or white, it’s kind of gray. I also hate those calls where it’s scripted, where you don’t actually have the analyst involvement. You’ve got someone who says pre-submitted questions only. And that, again, raises a couple of risk flags for us. Keep an eye out on that.

Look below the radar, because, yes, there’s the earnings transcript as well, but then there’s also the fact that we go and have a look at the financial statements. We go and have a look at some of the footnotes. What management presents to you at the earnings call on the earnings transcript is what they want you to focus on. And sometimes there are a couple of red herrings there. It’s very important to do this bottoms-up work. I’m getting a little bit sidetracked here because where we want to land this week on the show is looking at the Bull Box and what some of those key elements are that eventually lead to other segments of the research that we do in Magic Markets Premium.

Now, I’ve discussed, for example, the broader market trends, the macro trends, but specifically how the business is positioned. And this will inevitably come out in the bull or in the bear box, because a business’s ability to extract economic value is very different from the e.g. maybe there’s just a mega trend going on.

AI is a great example. You know, AI is a mega theme, and you’ve had phenomenal performances from some companies in that space. But a good example is if you go and have a look at Intel, well, they haven’t had such a great time, so you’ve got to look at the business positioning within the broader market trend.

Now, this also talks towards market share. Are they growing market share or is their market share shrinking? Are they a dominant player in the market? Have they just dominated for so long that because of the virtue of the size of their market share, this might choke off the growth? Is this a company that’s effectively priced for growth?

Those are elements from a macro perspective that then also tie into the third point I want to raise here, Ghost, which is just the extent of the moat, because you can be a company that’s well positioned, that’s growing really well. But if you are in a market where there’s no moat, or if you are a company that has no moat, well, you’re leaving the door wide open for disruptors. And we’ve seen that time and time again where you’ve got really great, strong, solid businesses. They have a commanding position in their respective markets. But because of that lack of moat, their eyes not on the ball, they leave the door open for disruptors to come in and fundamentally change the business model and effectively pull the rug out from what would previously have been a fantastic business.

Ghost, I’m going to stop there because I want you to come in with some of the other elements that you see as we unpack and build out that Bull Box.

 

The Finance Ghost: Yeah, the moat stuff is so important. It arrives at another point that we try and understand around all the companies we cover, which is are we looking at a disruptor or a defender?

Disruptors eventually become defenders once they have big enough market share. That is exactly what’s happening to Ulta Beauty right now, a company that we recently covered. For years and years, they disrupted the beauty, cosmetics, health and beauty retail environment. Now they are facing that disruption themselves. They built such a lucrative business, they’ve got long shelf life, they’ve got great margins on this stuff, and people want to get a piece of the action. This happens often. When a business is really great, competition comes.

 

Mohammed Nalla: Just a great example and another one that springs to mind, a stock we’ve covered in Magic Markets Premium, is Lululemon. When we first spoke about the stock, it wasn’t a brand that’s known to South African investors simply because I don’t think they have a presence in South Africa, but up here in North America they were really all the rage.

We spoke about it pre- the hype, I think because we actually saw that stock rally so strongly. They were a disruptor in that market. They were disrupting the established players like Nike. And guess what? While the markets changed, they’ve now switched very much into a defensive positioning. Go and have a look at the share price.

This shows you how it’s not a static thing. The point I want to land on here is that even a bull and a bear case, those are not static. Sometimes we have a great investment thesis on a company, great bull points. And when you look two, three quarters down the line, that one disruptive element you’re looking at maybe in the Bear Box has upset the apple cart or vice versa.

And this is why it’s so important to have both the Bull and the Bear Box. It’s just keeping these elements on your dashboard to make sure you know what to look out for in terms of the moving parts.

 

The Finance Ghost: In a business we look at loads of other stuff as well. Is it a global or a local contender? What are the underlying financial trends as we’ve talked about? And then the output of this thing is we will then pick pretty much the four most important high level points and we will then have a good few sub-bullets explaining each one.

You can come up with a hundred things in a bull case, but in reality the share price move is not going to be explained by 100 things. Or rather, a major share price move will not be explained by 100 little things. The market knows that Nike sells shoes that people like. That’s not a great bull case, really. You need to get more precise than that. You need to really think about what are the things that are going to actually move the share price going forward, what is going to make this company better and what is good about it. And there’s no one size fits all.

Often the footprint of a retailer is seen as a bull case because they have a strong footprint and so they can do stuff like omnichannel retail with it. They can do click and collect, etc. A big footprint is not always a bull point. Sometimes, it’s a bear point, sometimes it’s full of legacy stores that are losing money. It’s actually a huge issue because there are expensive leases that you can’t get out of and the store economics are poor and the whole business has changed. As I say, there really is no guaranteed input into a bull case versus a bear case.

That’s really what makes this so interesting and it’s also why it’s so good to just think through this stuff and critically analyse the business and just ask yourself, if you own this business, which is what you’re going to be doing if you buy shares in it, what do you really like about it? What would you not change? What do you think makes this business particularly great? And that is the bull case.

The strength of that bull case and the moat, which is really how well they can protect their bull case, is going to determine how much you should actually pay for this thing when you layer on not just the financial performance, but also the bear case, which we’ll talk to next week.

 

Mohammed Nalla: One last point I want to land on here is the fact that none of this is static. Another great example that comes to mind is a stock like Disney. Disney is a stock where in the Bull Box, you would firmly have at the top this content library – the IP that they built up over decades and generations. But when I say it’s not static and why I like to look at our Bull and Bear Box as a dashboard is that I like to map the trends in those points.

Do they sustain being a bull point in the business, or is the delta going the wrong way? Disney is a good example where there have been some missteps with regards to content, maybe investing in the wrong brands, the wrong type of content. The delta has been wrong. It still goes into the Bull Box, as this content library hasn’t disappeared, but the delta – the moving parts on where that bull point is going – is it sustaining its strength or is it waning in its effectiveness?

That’s something that’s so important because at Magic Markets Premium, again, long-time subscribers will have noticed this. We often do recaps because nothing in the market stays the same. Something that was, for example, a strong bull point one or two or even three quarters ago need not remain a bull point if the execution on that has started to slip.

Always keep this in the back of your mind. The Bull and Bear Box give you a nice balanced view of the moving parts in this business. What are the strengths? What are the weaknesses? Is the company able to sustain some of these strengths and then deliver on sustainable share price returns to the investors?

Ghost, I think that’s where we’ve got to leave it this week. I think it’s a nice synopsis in terms of just how we contextualise the Bull Box. We’ve touched on how some of that flows over into the Bear Box, how some of that flows over into the rest of the research that we do at Magic Markets Premium. For example, we do a deep dive on management, who’s actually heading up the company. What are insiders doing? We do a deep dive on the numbers, on the financials. And so it’s really the starting point in terms of your analysis – the strategic overview, the Bull and the Bear Box.

Next week, join us for how we look at the Bear Box, how we contextualise some of the thoughts and the building of the Bear Box, contributing to a balanced view on a stock.

Let us know what you thought of this show. Hit us up on social media. We hope you’ve enjoyed this. Until next week, same time, same place. Thanks and cheers.

 

The Finance Ghost: Ciao.

 

This podcast is for informational purposes only and is not financial or investment advice. Please speak to your personal financial advisor.