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November 13, 2023 -One of the secrets to good long-term investing is to find the right growth company early and hang on for the ride. It requires recognizing great management that can build a moat and use scale to create a long-term advantage. If you find one early and worry less about short-term market gyrations, you will likely do very well.

//  by Tower Bridge Advisors

Stocks surged Friday, more than recovering Thursday’s losses. Momentum increased throughout the session. Fear of missing out on the rally probably spurred some of the buying. As I noted last week, a sustained reversal (2+ days) created a classic V-shaped bottom. While bottoms often get retested, they don’t always. The lows set the first Friday in November may well prove to be the bottom of this correction.

That doesn’t mean stocks will surge from here. Valuation matters. Overall, stocks aren’t cheap, but that doesn’t mean there aren’t cheap stocks. We are approaching year end. Tax selling is elevated. That often means stocks that have been weak performers in 2023 stay weak until the bulk of the tax selling is complete. Similarly, stocks that surged in 2023 stay strong as investors choose to defer realizing capital gains until 2024. While this only applies to taxable investors, it does influence Q4 performance of individual stocks.

As for news, this is likely to be a fairly quiet week with a few exceptions. First, while earnings season is winding down, it is only beginning for most of the major retailers who have different fiscal years from most companies. Taking inventory in December is an absurd idea for retailers. Thus, they defer their fiscal year ends until January, and therefore report results a month later than most other companies. As they report, what will be key are their comments on the coming Christmas season. The second factor that will be key to stocks this week will be tomorrow’s CPI report. Trends in inflation have been a key focus since the Fed started to tighten monetary policy last year. Over the past several months, inflation has been trending lower. Given there are always month-to-month distortions, this will still be the prime focus point this week, one likely to affect the direction of long-term interest rates. Falling gasoline prices and moderating shelter costs should help.

I want to switch topics and focus on two keys that I find valuable when searching for companies that have the capability to be what famed investor Peter Lynch, the former head of Fidelity’s Magellan Fund, called 10-baggers, companies with the potential to rise 10x in price within a decade.

Before detailing the two factors, it is important to recognize two additional key points. First, few companies grow 10x within a decade. If you can identify just one or two in a given years’ time, that would be amazing. Second, you need to pick them relatively early in their growth cycle. Meta Platforms# came public as Facebook about two decades ago. After stumbling out of the gate, its shares fell below $20. Today it is around $300. I sincerely doubt it will be $3000 within the next 10 years. The top of the S&P 500 changes every decade. Decelerating growth, which follows the law of large numbers, makes staying at the top very difficult. As growth slows, P/E multiples decline. Thus, if you are looking for the next 10-bagger, don’t start with what we call today the Magnificent Seven.
With that said I will move on and discuss moats and scale. Investors often get overly excited about a new company with a great product. Remember the GoPro Camera? It’s still out there, but it was one product that became a fad, and was fairly easy to copy. Innovators get a head start, but when bigger fish jump into the arena, it’s tough to defend the lead. Visicalc was the first spreadsheet. When IBM introduced its first PC, it came with four program options- Visicalc, two word processing programs, and a crude computer game. Spreadsheets were for real. That meant others would emulate it, trying to go one better. Before long, Lotus 123 did just that. Visicalc faded. But Lotus couldn’t hold its lead either. Microsoft built Excel. Excel wasn’t necessarily better than Lotus 123, but Microsoft was larger and could integrate Excel with other software it offered including its own word processing program, and ultimately products like PowerPoint and email. Goodbye Lotus.

Rapidata and Bowmar made the first calculators. Radio Shack had the first portable computer. General Motors had the EV-1 years before Tesla built an electric car. But all lacked moats, that barrier that competitors have to cross in order to compete. Moats vary in size and complexity. Perhaps the best moat is patent protection, most evident within the drug industry. But even that moat isn’t perfect. A competitor can follow with a more effective drug, and patent protection is limited to a modest number of years. Real moats require several conditions. Once a product becomes a standard integrated in everything one does, it is hard for a newbie to take share. Look at a pdf files, for instance. We all use them. It has become a standard. The only reason to change is if a competitor introduces a product with obvious superiority. You know the moat is large when a product’s name becomes part of everyone’s lexicon. We Google when we search. Kleenex used to be a standard for tissues, Xerox for making photocopies. Moats don’t exist forever. Xerox is no longer a copier substitute and we read less on paper and more on screens today. But good moats last a long time.

Moats don’t have to be just within technology. Say hamburger, french fries and a Coke, and you instantly think of McDonalds, a 50+ year old company that still dominates its sector to this day. It has done so by constantly improving its offerings and remaining better than its competitors. There are regional competitors that can come close to matching McDonald’s but none that have become superior. Moats can be duopolies. Look at Visa and MasterCard, for instance. But rarely, are moats larger than two.

This brings me to the second key factor, scale. Size has its advantages. Big companies can afford to invest more to stay ahead. McDonalds has scale. Its franchisees pay 4% toward marketing costs. That’s billions to promote name recognition. Obviously, good marketing has to be backed by good products but it certainly squeezes out competition.

Perhaps better examples of scale are Netflix and Tesla. Netflix spends $15-20 billion per year on content. It produces content all over the world in multiple languages. Hits in one country can become hits in others, Squid Games being a prime example. It can produce hit movies and buy old TV series at the same time. There is always something new (not always good!) to watch plus a huge library of old, if the new doesn’t stimulate interest.

It’s clear that the world has moved to streaming. Netflix created the new world, built a big base, and has maintained it using scale to its advantage. It doesn’t have a real moat; any Hollywood studio can create a TV series or movie. But it has hundreds of millions of viewers willing to pay $10-20 each month to subscribe. A streaming network with 10 million subscribers can’t match it without losing a lot of money. It now has gotten so expensive that new entrants into the streaming wars are unlikely. Netflix is the only company today with positive cash flow. In time others will, but only after absorbing years of losses to build scale. Competitors are likely to combine attempting to reach scale. I don’t know how it will end, but scale and size are big Netflix advantages.

Moving to electric vehicles (EVs), Tesla has scale. It is on a path to producing two million cars per year. Except for a few Chinese manufacturers, no one else comes close. A car manufacturing plant is expensive. Thus, making a car carries a high fixed cost, one that can only be overcome with high volume. So far, in this country, no one else is close. Ford is already slowing its ramp up of EVs because it loses so much money making them. GM is scaling back its autonomous vehicle venture. Even companies that produce high end EVs that should carry big margins are bleeding red ink. Lucid, which makes cars selling for well over $100K, loses over $225,000 on every car it sells today. Insufficient volume. In time, there will be viable alternatives to Tesla, but today no one has the scale to compete profitably. Meanwhile, Tesla generates positive cash flow. When demand starts to wane, it simply lowers price allowing it to keep its lead while squeezing competitors already losing money. One reason Ford had to cut back was that it was forced to reduce prices of its Mustang EV to compete with Tesla as the latter lowered prices.

All these examples are backward looking. Tesla, Netflix, and McDonald’s may be successful investments in the future but they are unlikely to be 10 baggers going forward. All have been 10 baggers in the past. Where do we find the next one? As noted earlier, it isn’t easy. But here are some factors to look for.

• Start with great leaders. Every great company you can think of had/has a great leader. Steve Jobs at Apple#. Reed Hastings at Netflix. Ray Kroc at McDonld’s. Bill Gates and now Satya Nadella at Microsoft. Great companies build great future leaders. Think of Apple where Tim Cook was a great successor to Steve Jobs. There aren’t many 10 baggers who don’t have great leadership.
• 10 baggers are more than a single product. They are businesses originally built upon a product, that grow into businesses with a key product or products at its core.
• Great companies pivot. Microsoft moved away from being Windows-centric to being enterprise centric. Facebook pivoted from being desktop centric to being mobile centric. Apple pivoted from PCs to smartphones. Netflix moved from mailing CDs to streaming.
• Knowing success is copied, great companies build upon their earlier successes. 75% of McDonald’s sales today come through drive-thru windows. Speeding that process by seconds per customer is a key to its future.
• They add to their core base. Nike originally made running shoes. Not only do they now make shoes for all sports and non-sport uses, they also sell apparel and related items. Imagine what Amazon would be today if it just sold books online.

So, how do we find the next 10-bagger? Start in several ways. Look for industries with great growth potential. AI is an obvious one. Diabetes and weight loss are other obvious ones. There are many less obvious. Great companies change how we live. Who would have thought a decade ago that sneakers would accompany suits or that 80-year-olds would be wearing them every day? When was the last time you actually went into a McDonald’s to sit down and eat a burger? Watch any 30-year-old in an elevator and their face will be riveted to their smartphone. Are they reading email or watching a TikTok video?

The IPO market is a fertile place to start looking, but there aren’t many IPOs today and most of them are 10 bag pretenders, not the real deal. Sometimes, a great company is floundering, only needing that great manager to move it to the next level. Would Microsoft have been the great company it is today if Steve Ballmer were still running it?

Thus, it all comes down to three ingredients, great leaders, a protectable moat, and scale. You need all three to some degree. You also need a market opportunity that will be significantly larger a decade from now. No sense starting the next NBC or CBS today. The hunt is worth the time. One 10-bagger can make a huge difference in overall portfolio performance. You don’t have to get on the bandwagon at the start but you do have to get on fairly early. Don’t just chase pioneers or you will buy the next Blackberry. Make sure you have the right management with the resources to succeed. Happy hunting.

Today, Jimmy Kimmel is 56. Attorney General Merrick Garland is 71.

James M. Meyer, CFA 610-260-2220

Tower Bridge Advisors manages over $1.7 Billion for individuals, families and select institutions with $1 Million or more of investable assets. We build portfolios of individual securities customized for each client's specific goals and objectives. Contact Nick Filippo (610-260-2222, nfilippo@towerbridgeadvisors.com) to learn more or to set up a complimentary portfolio review.

# – This security is owned by the author of this report or accounts under his management at Tower Bridge Advisors.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only. It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Filed Under: Market Commentary

Previous Post: « November 10, 2023 – Stocks remain slaves to the bond market. A poorly received Treasury auction and sober comments from Fed Chair Powell helped to end the longest equity winning streak of the year. But unless rates surge back over 5% from here, the odds favor that the worst of 2023 is over.
Next Post: November 15, 2023 – Yesterday’s CPI report punctuated the notion that this rally is for real. Inflation is on its way to defeat, and later next year the economy will see blue skies ahead. Short-term issues like strikes and government shutdown threats are being resolved. The post-Covid impact is waning and the possibility of a soft landing is increasing. The sharp rally may be a bit overdone, but the likelihood that the October lows are the true bottom keeps increasing. »

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  • December 8, 2023 – Markets rallied yesterday but remained in tepid anticipation of today’s employment report and next week’s CPI report. The November employment report came in close to expectations with gains of 199,000. Not sure from the early read how much those numbers were enhanced by the end of the auto and Hollywood strikes. Markets reacted negatively to the report as month-over-month wages increased slightly more than anticipated. The unemployment rate fell to 3.7% as the labor participation rate rose to a pre-pandemic high.
  • December 6, 2023 – December has started off a lot slower than November, at least in the equity markets. While long-term interest rates continue to drift lower, so do economic expectations. Valuation also comes into play after a rally of close to 10% off recent lows. The key question over the next few months is how fast is the economy decelerating?
  • December 4, 2023 – Amid a period of no economic news, stocks and bonds continue to ride a wave of momentum. Near-term problems, like higher interest rates and a pending recession, appear to be receding while long-term problems, like surging deficits and out of control government spending are ignored until they become disruptive. While the long-term problems won’t disrupt the party at the moment, they will have to be addressed at some point.
  • December 1, 2023 – Stocks finished November with a bang. December is usually a kind time for equity investors, although adding to gains of close to 10% will be challenging. While we will get employment data a week from today and a CPI report the following Tuesday, the die appears to have been cast. Markets now expect inflation is dying and the Fed, which meets again within two weeks, is finished raising rates.
  • November 29, 2023 – Stocks continue to drift higher as the yield on 10-year Treasuries drifts lower. Seasonally, this is usually one of the strongest times of the year for stocks. While upward momentum has slowed lately, it hasn’t stopped. Perhaps the biggest news late yesterday was the passing of Charlie Munger at age 99. For decades, he was Warren Buffett’s investing partner at Berkshire Hathaway. While Buffett was always the consummate value investor, it was Munger who convinced Buffett that truly great companies don’t come cheaply. One can thank Munger for steering Berkshire toward Apple.
  • November 27, 2023 – A nice Thanksgiving weekend ended on a high note with another Eagles come from behind win. It was a weekend for the birds. Looking ahead, the corporate calendar is slim, beyond a bunch of early December analyst days which will impact individual stocks. The key employment and inflation numbers come out between December 8-12 just in front of the FOMC meeting that concludes December 13. Seasonally, the next several weeks are good for stocks. Hopefully, the coming data will support that bias.
  • November 22, 2023 – In a dull Thanksgiving week, two stories dominate: the turmoil at OpenAI, and the spectacular earnings at Nvidia. The two companies are linked. The explosive demand for generative AI has led to explosive sales growth at Nvidia. Alas, on Wall Street, it’s all about how expectations match up to reality. Expectations have exploded over the past year. Do they have further to go or are they getting ahead of future reality? That is always the dilemma investors face.
  • November 20, 2023 – This is likely to be a quiet holiday-shortened week. The big corporate news over the weekend was the ouster of Sam Altman as CEO of the leading AI company. The big earnings news this week will come from Nvidia tomorrow after the close. Expectations are high given Nvidia’s role as the producer of the most effective chips used to perform AI searches and create solutions.
  • November 17, 2023 – While changing interest rates remain the dominant influence on stock prices, weak earnings from Wal-Mart and Cisco were headwinds yesterday. But rates are taking over this morning pushing futures higher once again.
  • November 15, 2023 – Yesterday’s CPI report punctuated the notion that this rally is for real. Inflation is on its way to defeat, and later next year the economy will see blue skies ahead. Short-term issues like strikes and government shutdown threats are being resolved. The post-Covid impact is waning and the possibility of a soft landing is increasing. The sharp rally may be a bit overdone, but the likelihood that the October lows are the true bottom keeps increasing.

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