The Biggest Losers at the Peak

Introduction: Profitless at the Peak
Large Cap
Small & Mid Cap
Conclusion
Exhibits

Introduction: Profitless at the Peak

The bull market of the last 10 years has moved relentlessly higher in an ever more concentrated fashion, interrupted for the briefest of moments by a global health pandemic that sent markets into tailspin. Even a global pandemic that causes a worldwide shutdown with attendant declines in global GDP on a scale never seen in our lifetimes, record and rising levels of unemployment in a highly leveraged global economy with no clear path forward — merited only a 23 day crash. From the trough on March 23 the market, seeing record global stimulus and cheap money, soared back to levels seen as recently as October of 2019.

Kailash does not make market calls, but as noted in our recent piece, Crashes: When Losers Become Leaders Update, aggregate market valuations are either moderately rich to above the peak of February 19, 2020. The spread in estimates, in our view, depends on your assessment of how much government largess can offset the trauma on Main Street relative to Wall Street. This paper seeks to address none of the macro wrangling seen in the press but instead hone in on a select few firms where fundamentals have been deemed irrelevant through all this.

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In Kailash’s view, some companies that benefit from Wall Street promoters and/or private equity firms which author exciting “blitzscaling” narratives now have exorbitant market valuations. Proponents of blitzscaling emphasize that no loss is too large to ensure a first-mover advantage. Advocates promote the idea that these disruptive firms will end up in a winner-take-all seat and hence no valuation is too high. Kailash refers to this as “the Amazon effect.” For insights on the conundrum of the “Amazon effect” please see Amazon: Notes from Agnostics and the Academic Partner at Kailash’s paper Stock Compensation Expense, Cash Flows and Inflated Valuations.

Long-time readers know that Kailash is highly skeptical of such narratives. Believing instead that there are an abundance of “old” names with long operating histories and healthy balance sheets that will fare far better this year and in the ones beyond. In our view, the Amazon engine of equity valuation creation is the anomaly not the precedent. In this piece, Kailash focuses on firms that were “The Biggest Losers.” Said differently, The Biggest Losers are the 25 firms that lose the most per dollar of revenue in the Large Cap and Small & Mid Cap Space.

Those that embrace the concept that massive loss makers are a winning hand may find Kailash’s papers on Passive Vehicles and the Profit Penalty and Private Equity¹ of interest. Our view is as prosaic as it is empirical in nature. Companies that lose the most money per dollar of revenue during a period of peak economic performance with access to cheap equity and debt may lack credible business models.

Kailash holds fast to the belief that many of The Biggest Losers will inevitably suffer a brutal “WeWorks” moment. Some suggest that high valuations are merited in a zero-rate environment. Kailash’s admittedly old-fashioned view is that if rates are at zero, firms with 5%-10% earnings yields, long operating histories and healthy balance sheets should be prizes worth having. In contrast: losing money has never been a winning strategy over the long-term much less during times of stress.

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ADDITIONAL READING

The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra reading for anyone seeking out more information related to the topics above.

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