Q2 2022 - Investor Letter
7th July, 2022
It’s no secret we all find ourselves in an unusual (uncommon, unfamiliar, curious, uncertain, volatile) time. While the market environment has been difficult, we have reason to believe our longer-term theses are still intact. Rather than panic during these periods, we believe it is important to look at the fundamentals of the companies we own. One of our holdings, Silicon Motion (SIMO), was acquired by MaxLinear Inc. for approximately $106 yet it is currently trading at $80. Another, Rada Electronics, was acquired in a merger worth approximately $15 a share and is trading at $7.76. Both deals are expected to close in the fourth quarter of 2022. Clearly, there is a disconnect between what “the market” thinks versus what has been announced.
In addition, Full House Resorts (FLL), which we have written about in prior letters, is trading at one of the lowest multiples of enterprise value to EBITDA in the casino industry, yet it has one of the highest growth rates. We believe that once their new hotels and casino are completed the EBITDA can triple and the stock could be up 5 times the current price, or more. Another, Apollo Endosurgery is trading at 1.39 times enterprise value to revenue despite having substantial growth opportunities, ramping new products, and near-term catalysts.
We understand that these dislocations in the market can last longer than expectations due to fear (see chart below) and lack of liquidity, however, our confidence in the ultimate outcomes makes us hesitant to abandon these stocks in our portfolios.
“Be fearful when others are greedy, and greedy when others are fearful.”
- Warren Buffett
CNN Fear and Greed Index
The market is a discounting mechanism, and sometimes it over does it on both the upside and the downside. We believe that over the past nine months the market has discounted runaway inflation, an aggressive Federal reserve, and now a severe economic and earnings slowdown. The truth is that we just don’t know.
Much of the magnitude of this decline has to do with the expectation that current earnings growth projections are too high in a challenging economic environment. Interest rate hikes, inflation pressures, COVID lockdowns in China, the war in Ukraine, and wavering consumer confidence all, in aggregate, contribute directly to the biggest issue, which is future profitability. While it may be easy to get “wrapped around the axel” when it comes to “the market,” we continue to have confidence in the individual companies we own and their respective trajectories over the intermediate and long term.
If you tune out the noise, which is difficult to do, and focus on the portfolio, our confidence comes from our analysis for future revenue and earnings growth, and valuation. While we will not get them all right we will continue executing on our process.
We believe that on average, the stocks in our portfolio are trading at valuations that are below the market while their estimated growth rates are above the market as represented by the S&P 500, the Russell 2000, and the NASDAQ 100. The weighted average revenue growth across all the companies in GROW’s portfolio is 22% in 2023, this compares to 4.80%, 5.25%, and 8.96% for the S&P 500, the Russell 2000, and the NASDAQ, respectively.
We will continue to check and re-check our analysis to ensure our theses are intact, and we will continue to evaluate the companies we own. Historically, we believe that coming out of these time periods our stocks tend to do very well. While past performance is no guarantee of future returns and the timeline is uncertain, we believe that this time will be no different.
This quarter we would like to highlight Aehr Test Systems (AEHR). AEHR manufactures wafer test/burn-in systems used to analyze memory and logic integrated circuits for the semiconductor industry. In electric vehicles alone, AEHR has outlined the opportunity to be worth approximately $1 billion dollars. Specifically, AEHR operates in the silicon carbide market, which is slowly overtaking traditional silicon because of its capacity to absorb heat more effectively. In addition to electric vehicles, AEHR sees a significant adjacent market opportunity in silicon carbide for industrial applications, electrification infrastructure, and power devices which we believe could become an additional billion-dollar opportunity. They currently have one notable customer, ON Semiconductor Corp (ON), and we believe that other major semiconductor manufacturers will follow suit because of AEHR’s value add proposition. AEHR can test 18 wafers at once when all other competitors can test only one. This has the potential to relieve the bottleneck of slow production that has plagued the semiconductor industry for years. If companies are building new fabrication facilities (like Wolfspeed and STMicroelectronics are) there’s no reason why they wouldn’t want to have the most efficient testing equipment on the market on their production line. The stock is currently trading at 7.6 times forward earnings and is set to grow revenues 40% next year according to our estimates.
We thank you for your continued trust and support. While these times can be tumultuous, we encourage any questions or comments you may have. We are beginning to conduct portfolio reviews for our clients, so if you are interested in learning more about the names you own we would be happy to facilitate that.
The GROW Funds Team