What could small cap tech investors expect in 2023? 👓
Who knows?
With many of the companies that interest me having finished reporting quarterly updates ahead of half-year results in February, I’m patiently waiting in limbo between reporting seasons.
Hence, I took the time to reflect back on a short exercise I like to do at the beginning of a new calendar year. Looking at market predictions from last year is nearly guaranteed to offer some chuckles. It felt like a sarcastic joke when I was going through this exercise a few weeks ago and received a newsletter from another investor sharing JP Morgan’s prediction for 2022:
So much for long and impressive looking job titles.
You won’t be surprised either to hear that Marko and Hussein are not so bullish this year…Then, why would I be? Well, that’s because I’m answering a different question. I think that arguably, a better question ought to be:
“What can we expect the next 5 years to look like for small cap tech investors?”
Why be bullish now ⌚?
They say a picture is worth a thousand words. So here, in one picture, here’s why I’m feeling positive about the next five years:
My opinion is that the next 5 years are likely to be good years for small cap technology investors. In this post, I will share why I feel this way.
You may argue with me on forward PEs, stating that in many cases, forward earnings have not yet been reviewed downwards to reflect our new economic reality. That might be true, but when you own a small, concentrated portfolios of companies you understand well, you might be able to make a case that most will continue to outperform. In any case, we will find out the answer as the reporting season starts to unfold in the next few weeks.
What can’t be argued from this chart is how aggressive the selldowns have been. That’s a steep slope, and it reminds me of Howard Mark’s point on the pendulum.
“The mood swings of the securities markets resemble the movement of a pendulum. Although the midpoint of its arc best describes the location of the pendulum “on average,” it actually spends very little of its time there. Instead, it is almost always swinging toward or away from the extremes of its arc.
But whenever the pendulum is near either extreme, it is inevitable that it will move back toward the midpoint sooner or later. In fact, it is the movement toward an extreme itself that supplies the energy for the swing back.
Investment markets make the same pendulum-like swing: between euphoria and depression, between celebrating positive developments and obsessing over negatives, and thus between being overpriced and underpriced. This oscillation is one of the most dependable features of the investment world, and investor psychology seems to spend much more time at the extremes than it does at a “happy medium.”
― Howard Marks, Mastering The Market Cycle: Getting the odds on your side
The smart people are forecasting a recession 📉
The general sentiment appears to be quite negative out there. Yet, other credible sources claiming we might be in for a turn to the positive.
So who’s right? Well, no one knows for sure when the turn will take place, and certainly things could get worse before they start to get better (this is a lesson I’ve learned more than once). Ian Cassel talks about building a lifestyle you can sustain if your portfolio goes through 2 consecutive years of -30%.
Importantly, I try to remind myself that there’s a lot more upside potential now than one year ago.
My take on recessions is that there are still stocks that perform incredibly well in bad markets. REA group (ASX:REA) listed when tech investors were still licking their wounds from the tech boom of 2000, and became a 10 bagger in the two short years from 2001 to 2003.
Valuations at all time lows ⬇️
Going back to the chart above and keeping the idea of a gloomy recession in mind, I do see a possible near term future where larger companie’s stock prices may suffer, while smaller companies may not be as affected, and may even flourish.
That’s because the valuation of smaller companies, compared to their bigger peers, is currently at a significant gap. Many of the bigger companies haven’t seen the same correction their smaller counterparts have. This is true across industries, even software and technology.
As an example, Wisetech (ASX: WTC), the beloved logistics software giant, retains its high multiple of 30x sales. That seems a little steep in such a market. To their credit, Wisetech has executed well for a long time, and a track record or execution can (hopefully should) eventually get you a high multiple. I wouldn’t be rushing to buy in at such prices though, especially with the discounts we’re seeing in the world of small caps.
This disparity between large and small caps is a dynamic we’ve seen before. In a recent podcast, Steve Johnson of Forager funds shares a story of his personal portfolio having already recovered by 40% when the S&P was hitting its bottom in 2009. He was concentrated in small caps, which had been sold off prior to the big companies.
People have lost interest in strong fundamentals 😐
In a pessimistic market ripe with fear, the risky assets are the first to be axed from portfolios. Many investors have exited their positions in small technology companies in 2022.
I remind myself that when things look uninteresting is when they have the most potential for upside.
I find this resembles Lynch’s love for boring companies. A boring environment is one where people have stopped looking for opportunities out of fear that there are none.
That fundamentals are strong can’t be true for every company of course. In fact, it’s probably wrong for most companies, but in all bear markets we find companies who haven’t missed a beat, and yet have lost 50% of their market cap.
What are these companies on your watchlist ? Guaranteed you have plenty.
I have plenty too and that’s one of the things that got me most excited about the last 6 months. Case in point, I just wrote about 7 companies that have reported strong quarterly, and the majority of them are selling below their stock price from 2 years ago.
Conclusion
In closing, I revert back to my comments from the opening. It doesn't actually matter what happens in 2023. We should all have the right systems in place to be OK to live through another bloodbath like we did in 2022 if it were to materialise.
My opinion is that this year is more likely to go the other way. I like to take JP Morgan’s forecast and flip it on its head. I look forward to reading this post in 12 months and having a laugh at what I got wrong, and what I may have gotten right.
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