While Publicly Traded Plant-Based Meat Alternative Companies Are New, The Products Are Not

First, there was cannabis seller Tilray (TLRY), which saw its stock price peak at $300 per share just a few months after a mid-2018 IPO that priced at $17. A buying frenzy among individual/retail investors resulted in a more than 17-fold surge, but as it usually the case, sanity returned. Today TLRY can be purchased in the 40's.

This chart does not show the intra-day high of $300 but it did indeed peak at that price

With the cannabis craze now passed, as well as that of bitcoin, which stole the show in 2017, we have another round of exuberance with Beyond Meat (BYND), the plant-based meat alternative seller which priced its IPO at $25 last month and this week topped $200 per share.

While I lacked helpful fundamental insights into TLRY, outside of the always important valuation discussion, the "alt-meat" sector is something I know a little about because my wife is a vegetarian and we typically have very little in the way of actual meat products in our house. As a result, over the last decade or so we have tried most of the products out there. Some impress, others do not.

What I find perhaps most interesting about the last month is that because BYND is the first pure play plant-based meat alternative company to go public, those who follow the financial markets (but don't eat the products), seem to think that this market is brand new and that BYND (and fellow upstart Impossible Foods) are the first two companies to launch plant-based meat products. If there was indeed some sort of first-mover advantage, and the market for these items was brand new and growing like crazy, I guess one could justify paying a huge valuation for BYND. Though I think the current $10 billion equity value is beyond rich for even such a scenario.

The problem with that viewpoint is that plant-based burgers, ground beef, and chicken nugget alternatives are not new. Brands like Morningstar Farms, Quorn, Lightlife, Gardenburger, Boca, Field Roast, and Gardein have been at this game for a long time. In fact, market leader Morningstar Farms (owned by Kellogg), with annual sales estimated at $750 million, was started all the way back in 1975!

I suspect that people are noticing them more today because both Beyond and Impossible have been aggressively marketing their products and have succeeded in getting them on restaurant menus over the last couple of years (the legacy brands have typically focused on grocery store distribution). Sure, there are more vegetarians and vegans today than there were 20 or 30 years ago, but it would be a mistake for investors to assume that a couple of new companies are going to dominate the market and have no competition.

The market size is also an interesting topic, because in 2017 only 3% of Americans identified as vegan or vegetarian. If 5 companies battle each other for maybe ultimately 5% of the meat market in the U.S., it might be hard for investors to justify anywhere near a $10 billion market value for BYND, let alone a handful of players combined.

Some people are saying that meat eaters will eventually become big customers, but I doubt that will be true. Surely there will be some, as I enjoy many of the items with my wife (even though I do eat meat, poultry, and fish at restaurants), but I don't think specific situations like ours will be all that common, even five years from now.

So while these products are real, in many cases quite tasty, and the businesses are growing, the stock valuations are clearly out of whack. There is no way BYND is worth $10 billion when Kellogg's equity is valued at $19 billion and Conagra (the owner of Gardein) is worth $14 billion. Those companies have total annual revenue of $13 billion and $10 billion, respectively, while Beyond is projected to book sales of $300 million in 2020.

Much like cryptocurrencies and cannabis, many investors seem to be overestimating the alt-meat market opportunity (through insane stock market valuations). This is not to say there won't be winners and profits won't be made, but in a rush to want to own shares of what could be the "next big thing" valuation gets thrown out the window in favor of momentum and excitement. That typically does not end well. After all, the saying "buy low, sell high" was never shortly replaced by "buy high, sell higher" mainly because that strategy rarely works over the long term. Tilray speculators learned that and I suspect BYND bulls will as well.

Lastly, if you are curious and want to try some of the legacy alt-meat products (and compare them with BYND to see if they really have a better mouse trap), here are our favorites:

The IPO Market Has Taken The Baton From Large Cap Tech And Is Running Like Crazy

For several years until recently large cap technology companies were carrying the U.S. stock market on their backs. The nickname of FANG was even coined to describe the group, which included Facebook, Apple, Netflix, and Google. However, all of those companies saw their stock prices peak in 2018 and move in sideways fashion since, which has resulted in the S&P 500 doing the same over the last year:

With the tech sector comprising more than 30% of the S&P 500, as big tech stocks see their rapid ascents halted, so does the overall market...

However, with the economy doing well and stocks having rebounded from their Q4 2018 swoon, there are going to be pockets of strength in the market regardless. For a while it was cannabis stocks but now it appears to be the IPO market.

While the valuations are not as extreme as they were in 1998-2000 with the tech bubble, they nonetheless don't jive with the underlying financial profiles of the companies. Beyond Meat, which will wind up being among dozens of alt-meat competitors, should not be valued at $10 billion (for example). Unlike high margin tech companies like Facebook or Google, traditional businesses like food manufacturing or general merchandise retail have low margins and therefore will not result in large price-to-sales multiples over the long term.

I bring up the latter category because today's IPO winner du jour is online pet store Chewy.com (CHWY), which price its IPO at $22 per share and nearly doubled to more than $41 before 11:30am ET. At that price, CHWY's market value is $17 billion.

Chewy is growing very fast and could very well reach $5 billion in annual sales this year. That sounds great, and at a tad over 3 times annual sales, maybe the stock is not mispriced? Well, let's not forget that Chewy sells pet food online and ships it to their customers. This is not a revolutionary business model, and it certainly is not cheap to operate. Cost of goods for Chewy is above 75% and operating margins are negative. If the company decided to grow more slowly and cut marketing expenses from 10% of sales to 5% of sales, they could perhaps breakeven.

Even in a world where Chewy reaches $10 billion of sales and manages to turn a profit, the valuation should be relatively meager. General merchandise retailers like Costco, Target, Wal-Mart, and Best Buy all trade for less than 1x annual sales in the public market. This is because margins are relatively low (EBITDA less than 10% of sales) and retailers tend to trade at or below market multiples because they are simply middlemen/resellers of products that someone else makes.

Will the share of pet care continue to move in the direction of online e-commerce transactions? Almost certainly. Will Chewy be forced to price very competitively to win share from Target, Amazon, and Petco? Absolutely. Will they be able to ever make big profits by selling cat litter online and shipping it to your house? Of course not.

If Chewy trades at 1 times annual sales five years from now, it has to grow its business by28% annually during that time to be be worth today's price in 2024. For investors who buy it today and expect a 10% annual return over the next five years, Chewy would have to grow 40% per year through 2024.

So is Chewy the next big thing or just the most recent example of an overpriced new IPO? I would bet on the latter and will be paying close attention to see if high valuations persist when many recent IPO are available to short with minimal cost.

Full Disclosure: No position in Chewy at the time of writing

(Author's note added at 6/14/19 12:40p ET - Petsmart bought Chewy in 2017 for $3.35 billion, so they are sitting on a 5x return in 2 years, to give readers a sense of the valuation inflation going on here)

Why Tech Is Likely to Withstand Antitrust Inquiries

Mega cap technology companies are now facing heat as the federal government continues the process of investigating their market positions as it relates to antitrust/monopolistic issues. Some politicians are calling for breakups of tech companies. The narrative within the investing community seems to be that Microsoft (MSFT) was severely crippled by an antitrust settlement nearly 20 years ago, and as a result, this could get ugly for today's tech leaders as the FTC and DOJ take closer looks.

So I decided to go back and see exactly how stifled Microsoft's growth was after the government's lawsuit was settled in 2001. The answer might be surprising:

MSFT Fiscal 2001 Sales: $25.3 billion

MSFT Fiscal 2001 EBITDA: $13.2 billion

MSFT Fiscal 2011 Sales: $69.9 billion (+176% vs decade prior)

MSFT Fiscal 2011 EBITDA: $29.9 billion (+126% vs decade prior)

If the Microsoft case is supposed to be the poster child for how a government lawsuit can kill your business, it does not seem to be much of an issue, and certainly not to the extent investors are worried right now. Interestingly, while MSFT initially lost their case, they prevailed nicely during the appeals process, which ultimately led to a settlement that had the effect of "limiting" the company's EBITDA growth rate to +8.5% annually for the ensuing 10-year period, with revenue rising even faster (+10.7% annually).

Keep in mind that we are very early on in the process today, with regulators just now deciding who will take a look at each company. It will take years for them to draw a conclusion, possibly file a lawsuit, potentially prevail in court, then have to defend during an appeal even if they win, and only then would tech firms have to adapt to any stipulations.

Perhaps more importantly, I think it is helpful for us, as users of these tech products, to ask ourselves if we believe that the mega tech companies of today have grown so large because they have created things that consumers find helpful and value-creating in their lives, or if it is more due to them simply using their power to force consumers to use their stuff. Perhaps more now than at any other time, it seems to me to be the former. As a result, it is hard to argue that consumer are being unfairly harmed with offerings such as free 1-2 day shipping with Prime, a free multi-featured Google Maps app for their phone, and a social network platform where anyone can sign up, post anything they want, and share it with whomever they want.

Coca Cola Bottling Shares Surge 130% After Name Change: Could FinTech Be To Blame?

Hat tip to Upslope Capital for bringing this to people's attention. It appears that do-it-yourself investors relying on tech platforms to invest need to be even more careful than some may have previously thought. Sure, having a computer decide your asset allocation could be problematic long term, but it turns out that even someone trying to buy Coca Cola stock might get into trouble if they don't do their homework.

Whereas Coca Cola trades under the symbol KO, their largest bottler/distributor trades under the symbol COKE. The latter used to be called "Coca Cola Bottling Co Consolidated," which made it easier to understand which stock was which (given that the "real" Coke did not trade under "COKE"). Then in January the bottler changed the company name to "Coca Cola Consolidated" and dropped the "Bottling" completely.

So what happened? COKE shares almost immediately surged more than 130%:

So much for being just a boring bottler of soft drinks... COKE shares rally from under $130 to a peak of $413 in just four months after a questionable name change.

What could possibly have prompted such a huge move in this once boring stock? Well, one theory was floated by Upslope Capital; the name change itself!

If you read through their report (linked to above at the outset), you will notice that users of the popular Robinhood investing app have gobbled up COKE stock this year, likely due to the fact that searches for "Coca Cola" bring up the name of the bottling company with the stock symbol COKE. If you were a young, amateur investor, you probably would not think twice about putting in a buy order thinking you were getting shares in the mega cap global beverage giant that counts Warren Buffett as an investor and sports a total market value of more than $200 billion (70 times bigger than the bottling company!). And then you would wind up with an investment in the far smaller bottling company. And worse, your fellow investors would be doing the same, helping to push the stock up more than 100% in a matter of months!

While the air has come out of the balloon in recent days, COKE is probably still overvalued at $316 per share. I suspect sometime over the next year the stock trade back to $200 or $250 and plenty of investors will wonder exactly how they lost so much money on such a dominant company's stock.

While technology surely will play a role in evolving the investment process for many, the idea that hiring a human being to assist you with your savings and investment objectives is unlikely to become outdated for the majority of folks, for reasons exactly like this one. Sometimes the computers are going to be value-destructive, not value-additive as intended.

Full Disclosure: At the time of writing, I am short shares of COKE, but positions may change at any time.

Not Enough U.S. Cash Burning IPOs for You? Here Comes China's Luckin Coffee

Just as U.S. investors are trying to make sense of the Uber (UBER) and Lyft (LYFT) IPOs, both disastrous for those buying at the offer prices, on Friday we will get a U.S. listing of Chinese-operated, Cayman Island-incorporated coffee upstart Luckin Coffee. How much should investors pay for this so-called Starbucks of China (even though its business model is not copying the Seattle-based giant)? Quite frankly, who the heck knows? If that is not a sign that one should pass for now, I don't know what is.

Below is a summary of Luckin's financials from the IPO prospectus, though keep in mind its operating history is short (having gone from zero to 2,370 stores between October 2017 and March 2019).

This income statement reads like a Silicon Valley cloud-computing start-up, not a Chinese bricks and mortar coffee chain

As you can see, Luckin's stores are run at a loss, with Q1 2019 sales of $71 million dwarfed by direct store operating costs of $83 million and another $25 million of marketing expense.

Investors should not exactly be enamored with Luckin's growth rate. After all, selling coffee at a loss is an easy way to rack up sales and there is no way that the company has a detailed, refined, and proven unit expansion plan in place given that they are opening these money-losing locations as fast as humanly possible (an average of more than 4 new stores a day since they launched 18 months ago!).

None of this says anything about the long-term odds of success for Luckin Coffee. They could very well become China's largest coffee seller and make money doing it. There is simply no way to know at this point, so investors are left deciding whether they want to take a gamble or not. Many will given that the company will list on a U.S. exchange this week, but with no sound financial model to back up the prices being paid for the shares, there is really no fundamental case to be made for buying the stock.

All one can do is estimate what they think margins could ultimately be based on the business model, assume long-term success, and calculate an imputed price-to-sales ratio worth paying today given certain growth assumptions. That is how Uber and Lyft are likely to be valued (assuming people care to value it at all), and the same idea applies to Luckin Coffee and whatever the next cash-burning IPO waiting in the wings happens to be.

Author's note: To give you an example, assume that Uber can ultimately earn 20% EBITDA margins over the long-term and one can justify paying 15x EV/EBITDA given their potential growth outlook. That valuation equates to an EV/sales ratio of 3x, which based on 2020 revenue projections could yield a per-share fair value in the $30 ballpark (vs today's quote of $40).And don't even ask me to guess what Luckin Coffee's margins could be.

Gaming Update: Wynn Set for Boston Opening and Why Penn Looks Dirt Cheap

A lot has been going on with Wynn Resorts (WYNN) since my last post about six months ago so I figured it was time for an update. In addition, I recently significantly increased long holdings in regional gaming operator Penn National (PENN) and will share some brief thoughts there.

Shares of WYNN have continued in seesaw fashion, as the Massachusetts Gaming authorities held hearings to determine if it would allow the company to keep its gaming license in the state and open its Encore Boston Harbor property on schedule this summer. After a lot of tough talk, WYNN was fined $35 million for how it handled its former CEO amid inexcusable behavior, but got the green light for the Boston resort, and the stock has firmed up with the uncertainty cleared up.

It will take some time before we know exactly how profitable the new property will be, but I have been sticking with my $2 billion EBITDA target for 2020 throughout my holding period, and there is no reason to think that figure will be materially off base at this point.

If we apply an EV/EBITDA multiple of between 12x and 13x on that cash flow number, fair value for WYNN shares would be in the $155-$175 range, compared with the current price in the 130's. On a free cash flow basis, a 15-18x multiple on my $1.1 billion estimate (once Boston has stabilized), gets us to a fair value range of $154-$185 per share.

As a result, the stock is still well priced for longs, but given that it moves up and down a lot quite quickly, there could be an exit point approaching near the bottom end of that range if one can find other opportunities with even more upside.

On that front, I really like shares of Penn National Gaming and have been buying a lot more at $18 and change this week. PENN is the nation's leading operator of regional casinos, with more than 40 properties in nearly 20 states. Competition is typically intense, as jurisdictions often grant additional licenses in order to try and maximize tax revenue, but PENN has proven to be as solid an operator as they come, and does not shy away from accretive M&A deals when given the chance.

PENN shares have been cut in half from their 52-week highs despite a highly accretive merger with one of its largest peers (Pinnacle), and continued single property acquisitions - such as Greektown in Detroit.

The stock has been crushed lately and in the high teens fetches an EV/EBITDA multiple in the mid 6's. The free cash flow multiple is even more extreme at sub-6 times. With sports betting now legal, the company should benefit over the long term, as more and more states pave the way for taking bets. While the margins on betting won't be huge (the house takes a 10% cut and then gives a nice chunk to the state via taxes), it should be an incremental positive, and ancillary revenue such as food/beverage and hotel stays should get a nice bump as well.

Regional gaming assets typically fetch around 8x EV/EBITDA in private transactions and I see no reason a diversified operator like PENN, with a long track record of impressive capital allocation on behalf of shareholders, should not trade at a similar multiple, if not a slight premium. The market does not agree at the moment, but there is a great chance that at some point in the next couple of years that sentiment will change.

If we assume further deleveraging in 2019 and into 2020, my financial model shows a per-share fair value as high as $30 per share, assuming a valuation of 8x EV/EBITDA and a net leverage ratio of 2.5x excluding lease obligations.

Will A Barrage Of Tech Unicorn IPOs Mark The Top?

Back in the tech bubble of the 1998-2000 era investors were left holding the bag because they paid up mightily for small, fast-growing companies that were losing money but promising dominant long-term businesses based on fast growing end markets. Paying 15 or 20 times annual revenue became the norm because earnings were negligible. Sell side analyst recommendations went something like "we recommend shares of XYZ at 15x our forward 12-month revenue estimate, as peers are trading for 20x."

During the current bull market there was not a lot of this kind of froth in the tech sector, even though it has once again grown to be the largest in the market (31% of the S&P 500 by market value today). Companies like Apple, Facebook, Google, and Microsoft were growing nicely and had a ton of GAAP profits and free cash flow to back up the valuations. There were some exceptions like Amazon and Netflix, but it is hard to argue that they will not achieve solid profit margins at some point, and they are likely going to dominate their sectors on a global basis (exactly what those margins ultimately will be is an open question, and certainly up for debate).

Over the last year or two, cloud-based software companies are copying the Amazon/Netflix model. Given annual growth rates of 20-30%, investors are giving them a pass, despite stock-based compensation costs that are well into the double-digits as a percentage of revenue, and with sales and marketing budgets of 40-60% of revenue (whereas something more like 20-30% used to be the norm). These stocks trade at 10 times sales or more, and for that reason I cannot justify investing in most of them, but given that they are software businesses with high gross margins, these firms could make nice money today if they wanted to (cut sales and marketing to 20% of revenue and viola, your margins explode).

But as long as the public markets are valuing your stock as if you were already at peak margins and still growing 20-30% per annum, there is no reason to change your behavior. And since they can pay their employees with lots of stock, most of these companies are not burning much cash, if any, so the balance sheets are in good shape.

This week I believe we are seeing the next phase of the tech cycle with the Lyft IPO. These tech "unicorns" (firms with private market valuations of at least $1 billion) are about to flood the market with initial public offerings in 2019 as venture capitalists seek to cash out.

But something is different with these unicorns like Lyft; the income statements are gut-wrenching and look a lot more like 1999. But don't take my word for it, here are Lyft's results for 2016, 2017, and 2018, taken right from their IPO prospectus:

Losing $911 million on sales of $2.15 billion is no small feat, yet it is one the marketplace deemed worthy of a $25 billion valuation at Lyft's $72 IPO price. With the stock peaking at $88 on the first day of trading and now fetching just $71 on day #4, the jury is out on whether the public market will accept these businesses at these prices.

The biggest problem, though, is not Lyft per se. It is that there are plenty more of these unicorns coming. Let's take a look at a list of 10 unicorns that have talked about, or already started the process, to go public in the next 12 months, along with recent private market valuations:

Uber $120B

WeWork $45B

Airbnb $30B

Palantir $20B

Pinterest $12B

Instacart $8B

Slack $7B

DoorDash $7B

Houzz $4B

Postmates $2B

That's 10 companies worth one quarter of a trillion dollars in total (more than 1% of the entire S&P 500 index) and every single one of them is losing money hand over fist. Who is going to buy all of these IPOs? What assets are going to be sold to make room for them? How many money-losing companies really should be publicly traded? Will small investors be left holding the bag this time around too? Will a deluge of cash-burning tech stocks with "good stories" mark the top of this market cycle?

I don't know the answers to these questions, but as we look out at the rest of 2019, I do think this unicorn IPO frenzy is a material risk to market sentiment. And if Lyft traded below its offer price on day #2, what does that say about everyone else who decided not to "go first"? In the end, is Lyft really that much more than a taxi service? We'll find out over the next few years, I guess.

If you are a do-it-yourself investor who is thinking about playing in these IPOs shortly after they debut, please tread carefully. Sure, there will likely be at least one or two big long-term winners mixed in, but I suspect many more will be quite disappointing.

Somebody mentioned on CNBC this week that Uber and Lyft feel a lot like Sirius and XM did in the satellite radio space. Once they reached scale they make good money, but they really are just media companies. And in the end, there was only room for one player so they merged to survive. I would say the same thing might be true for the food delivery services. Do I really need Amazon Restaurants, DoorDash, Uber Eats, Postmates, GrubHub, and Bite Squad to go along with apps from Domino's, Pizza Hut, and Papa John's? My head hurts just thinking about it.

Why I Am Selling Apple in the 180's

While technology giant Apple (AAPL) has not been a large holding at my firm for a long time, until recently my clients did have some residual shares with a very cost basis as a result of paring back their legacy positions over time. In recent days I have been selling off those shares.

For many years Apple stock has gone through cycles whereby the valuation looks a lot like a hardware company (10-12x P/E ratio) at times when sentiment is skeptical, and a higher near-market multiple (mid teens) when investors are focused on services and other higher margin, recurring revenue streams.

Last year the shares got a boost from Warren Buffett's purchases, sentiment was high, and the stock above $200 was sporting a market multiple. After an early January profit warning for Q4, the stock fell into the 140's and the iPhone's issues in emerging markets came into focus. Just two months later, the stock has regained momentum and now trades well above the level it stood before the Q4 disappointment. Why, exactly, is an interesting question.

What is clear to me is that the iPhone problem has not been resolved in the last 60 days. The device's price continues to increase, which will serve to limit market share gains in emerging markets where household incomes are low and competing phones are close on features but priced much lower.

The notion that the iPhone will reach penetration rates globally in-line with those of its most successful regions, like North America, seems unrealistic to me. Given that the iPhone's share in the United States remains below 50%, despite it feeling as though everyone here has one, it should not be surprising that Apple has 25% market share in China, or just 1% market share in India. And Apple's decision to stop releasing unit sales figures for the iPhone only further reinforces the notion that material unit growth is over (iPhone unit sales actually peaked all the way back in 2015 at 231 million and have fallen more than 5% since) and revenue gains will be generated from pricing power, which will only serve to compress unit sales even more over time.

With iPhone having peaked, the next big thing for Apple was supposed to be recurring, high margin services revenue, but that thesis has played out only mildly in recent years. Services comprised 14% of Apple's total revenue in 2018, versus 9% five years ago. In order for investors to genuinely view Apple as a subscription company, they probably need that figure to be at least 40%, and that will take many years, if it ever happens.

We will soon hear about the company's newest services offering; a streaming video product, but that market is so crowded it is hard to see how they will be able to rival Netflix, Hulu, Prime Video, and the forthcoming Disney service. Press reports indicating that Apple CEO Tim Cook has been reading scripts and providing feedback for their shows in development should also worry investors. Should the CEO of Apple, who has no experience in the media content creation business, really be spending his time reading scripts? Doesn't he have better things to be doing? I fear the answer right now is no, which also presents a problem in terms of future innovation breakthroughs at Apple.

We are left with a company that is seeing its largest product (the iPhone is >60% of revenue) hit a wall and has little in the way of exciting new stuff in the pipeline. I do not expect the video service to be a big winner (they should have just bought Netflix or Disney instead), they have abandoned the electric car project (which seemed like an odd match for them to begin with), and more obvious areas for them to tackle (the high-end television market) have long been rumored without any results. Why Apple hasn't come out with a beautiful, premium priced all-in-one slim television device that integrates all video services seamlessly via voice control is beyond me. You can get one from Amazon at a bargain price, but the high end of the market remains untapped.

At the current price, Apple fetches about 16x times current year earnings estimates, versus the S&P 500 at around 17x. That valuation is high on a relative basis historically, and the company's future growth prospects look more muted than in prior years. The iPhone's competitive issues in emerging markets remain a problem without an easy solution (price cutting is not in Apple's DNA), but the stock market has quickly forgotten about that and sent the stock up more than 30% from the January lows. Without material multiple expansion, or significant underlying revenue growth, it is hard to see much value in Apple's shares in the 180's (or extreme downside either, to be fair), and as a result, now seems to be a solid exit point.

For a replacement, I find Facebook (FB) quite interesting. Sentiment is weak, the valuation is quite attractive relative to future growth prospects (21x this year's estimates, which are flat versus 2018 levels given the current spending cycle -- which should be temporary). As a result, over the next three to five years I would be surprised if Apple outpaced Facebook in terms of stock price appreciation.

Full Disclosure: I have recently been selling client positions in Apple and replacing them with Facebook, but positions may change at any time.

What A Difference A Decade Makes!

There was a lot of talk on CNBC this week about the trailing 10-year returns of the S&P 500 index and what, if anything, they tell us about the duration of the current equity bull market. Interestingly, the U.S. stock market bottomed at 666 on March 6, 2009, and has since returned nearly 18% annually for a decade.

The consensus view is that periods of strong market returns are often bookended by low valuations on one side and high valuations on the other side. That is certainly the case in this instance, and I am not sure it tells us very much about the current bull market (in terms of when it loses steam). Using the intra-day bottom during the worst market environment in nearly 100 years, as a starting point, is almost assured to subsequently produce a decade of strong returns.

While we cannot use this data to predict the next bear market, it is noteworthy that the market does tend to go in cycles that last one or two decades. The last 10 years have been characterized by strong index returns, and the rise of the index fund as the go-to investment option for individual investors. But I would argue that recency bias is playing a large role in this trend.

Consider that from January 1, 2000 through December 31, 2009, the S&P 500 went from 1,469 to 1,115, a loss of 24%. Dividends made up for a lot of the decline, such that $1 invested in the index including dividends was worth 91 cents in the end, but still, that decade produced a cumulative loss of about 1% annually.

Perhaps that is why there were not nearly as many people piling into index funds 10 years ago. They work... until and unless they don't. Just as the economy and the equity market are cyclical, so to will be the popularity of index funds.

Interestingly, even Warren Buffett (arguably the greatest active portfolio manager in history) has been bitten by the index fund bug, having recommended them many times in recent years.

Side note: I think the saying "do as I do, not as I say" is fitting here. While Buffett now praises the index fund category, it is important to note how the 88 year old plans to transition his stock picking duties at Berkshire Hathaway when he is no longer around. Move all of his investments into index funds? Hardly. Instead, he has hired two hedge fund managers, Todd Combs and Ted Weschler, to take over management of Berkshire's stock portfolio. Fascinating.

So what can we expect over the coming decade for the stock market? Well, it is not exactly going out on a limb to say that returns will likely average less than +18% and more than -1%, but that is a start. After all, the coming decade is unlikely to be as good as the go-go 1990's, or as bad as the ten years immediately following them.

History would tell us that average returns will be somewhere in the single digits. I won't hazard a guess as to whether we get 3%, 5%, or 7% a year, but I think mid single digits is as good of a guess as any based on historical data. It will be interesting to see if, in such an environment, index funds remain the asset of choice, or if tastes shift to something else (and if that something else is already in the marketplace or if it has yet to be created).

Chipotle Valuation Surging to Dizzying Heights, Surpassing Amazon!

It should not be surprising that hiring a veteran restaurant executive to replace an inexperienced founder will have a material impact on the business and its stock. Chipotle Mexican Grill (CMG) is a classic example, as Steve Ells stepping aside for Brian Niccol (formerly of Taco Bell) has launched CMG's shares into the stratosphere:

CMG's customer traffic has rebounded (+2% in Q4 2018) after flat lining earlier in the year and material price increases (+4% in Q4 2018), which were sidestepped after the e coli incidents, have same store sales rising 6% and profits surging even faster. The current analyst consensus estimate has CMG earning $12 per share in 2019 on a mid single digit same store sales increase and 5% unit growth. Those figures would place CMG near the top of the sector.

As is often the case, the biggest issue is the magnitude of CMG's recent stock gains. At more than $600 per share, CMG's forward price-earnings ratio is a stunning 50x. Why a casual dining chain with 2,500 locations already should trade at such a valuation is hard to understand, unless one believes they are going to steal a lot of market share going forward from here. Many folks believe that will happen, but I am less excited.

To give readers a sense as to how nutty this CMG valuation appears to be, let's compare it to Amazon (AMZN). I know AMZN is not a dining stock, but I find it to be an interesting comparison because they are both loved consumer brand stocks right now. Not only that, I would venture to guess that an investor poll would conclude that Amazon's business is better than Chipotle's and is likely to grow revenue and profits faster over the coming decade. And yet, today we can invest in Amazon at a cheaper valuation:

Looking at 2018 reported financial results, CMG trades at 31x EV/EBITDA, versus 28x for Amazon. I used EV/EBITDA to account for balance sheet items as well, but on a P/E basis the numbers are also similar: 50x for CMG and 59x for AMZN.

For those who are intrigued by Chipotle stock, I would simply point out that Amazon has long been a loved growth stock for which investors are often willing to pay sky-high valuations for. Today an argument can be made that CMG is more expensive and you would have a hard time finding people who expect CMG's business to outperform AMZN in coming years.

If that's true, either CMG is overvalued quite a bit, or AMZN is relatively cheap, or both. I would bet that AMZN outperforms from here. For those who like paired trades, being short CMG against an AMZN long looks interesting.