Timing the Market, and Enough Conviction Not to Sell

Jason’s Random Words

First things first. When you read Jeff's contribution later, there will be something Jeff believes about some stupid stock he likes. He's wrong. Okay, onto my (useful) thoughts.

When Jeff and I were talking through the stocks in the 2023 Smattering Portfolio Contest (if you haven't listened, this is the episode where we introduce the contest) on this week's podcast episode, we both mentioned a few times how we realize it's a short-term contest, and that means that there's a lot of luck that comes into play in these sorts of things.

But as I've been thinking about it more in the days since we recorded, I wonder if luck isn't the best word to use. Randomness? Chaos?

Anyways. I'm (very) prone to overthinking things. But there's a point. Stocks are volatile in the short term. Morgan Housel has often called this "the price of admission" to investing in stocks. But I think it's one thing to know that it happens while being far more useful to know why it happens. Actually, that's not true either. Because then we try to figure out why a stock went up or went down. And generally, if the answer isn't obvious, we should immediately stop looking.

For example, Trex, the maker of wood-alternative decking. Great company with a wonderful history of returns for investors, growing earnings per share, and taking market share. But this has been a terrible time to be in that business. Rising interest rates, buyers pulling back, inflation (and people still spending so much on travel and experiences) taking a bite out of discretionary spending power. Sales are down. Orders are down. So of course the stock is up 50% since late December. I can't tell you why, exactly. Beyond people think it's going to go up so they're buying it.

I'm fine with this. I own Trex. It's a wonderful company, but not 50% more wonderful than it was six months ago.

Trex isn't alone. The S&P 500 is up 15% so far; a good year-and-a-half, six months into 2023. That pales in comparison to the Nasdaq, up 31% this year.

Remember how much people were talking about bonds and money markets and high-yield savings and we should all be holding more cash back in January and February? Timing the market is hard.

The lesson: First, I don't think it's particularly useful to try to figure out why the stock market or a particular stock is up, or at least worth trying too hard. If the reason isn't obvious, then the answer is "other people believe differently than you" and that's it. Move on. What matters more – and this is the main lesson – is whether the change in the stock price is relevant in terms of any action you need to take. Do you need to sell stocks to raise cash or buy bonds or is it time to buy stocks and Trex is on your watchlist?

In either case, it's probably not relevant that the stock is up 50% this year. There are other questions that matter more, including some psychological ones (am I gonna check the stock price every day now because I don't want to "lose" money if the stock falls) and some mechanical ones (is Trex an appealing valuation to buy) that you need to answer first.

The point: Stocks go up and they go down, and sometimes in ways you didn't expect. It's a feature of the market, and the way you deal with it is building the mental skills to accept it, and the wealth-creating framework to support your long-term and short-term goals, and keep stocks in the proper context as a long-term tool. The Dude put it best. There are no facts about whether a stock should have gone up or down. It's just, like, your opinion, man.

Jason

Jeff’s Random Words

In last week’s newsletter, I wrote about the idea of having “enough conviction not to sell” a stock. I asked for readers to use the comments section to share a stock that might fit that description. Hat tip to our reader Joshua Johnson who took me up on this, writing:

“I have been considering selling my stock in Zoom, but I haven’t done so yet because I still have strong conviction in the company. On one hand, Zoom’s growth is sluggish, and they face intense competition. On the other hand, Zoom exhibits robust cash flow, and I have faith in Eric Yuan, the founder and leader, to steer the company beyond being just a video call app. I keep telling myself…just a few more quarters. I guess we’ll see.”

I was happy to have a response to consider (so thanks, Josh) and it was interesting that Zoom was the stock chosen because I had a similar take on the stock as Josh before ultimately selling (I’m certain this means Zoom will outperform from here…and that nothing I ever write should be taken as investing advice).

I want to share a stock from my portfolio that I don’t have high conviction in right now, but that I do have “enough conviction not to sell”, and that stock is Roku.

Let me begin by saying why I bought Roku in the first place. I bought it because it was a recommendation in a Motley Fool service I was a subscriber to. It was also in December of 2020 when I was still very new to investing in individual stocks and my entire process was buying Motley Fool recommendations. I bought Roku at 27 times sales. In retrospect, that was dumb. Really dumb. That’s too expensive. Anyway…

I haven’t added to this position in almost a year, and my two summer 2022 purchases were more about lowering my cost basis than they were about having super high conviction in the stock. Ok, it was also about proving Jason wrong because he argued against me buying more at the time. Turns out he was right, the stock is down another 22% from my last purchase. But I did win Q2 of our 2023 portfolio contest so I’m gonna brag about that at least one more time here.

Ok, back to Roku. I have a pretty basic view of the company and it’s why I haven’t sold it yet. Roku’s basic business model is to sell cheap devices and TVs so that it can grow its customer accounts, and get those customers to watch more hours, so Roku can serve them ads and monetize them. That’s it.

To that end, they’re still kinda doing those things. Here’s how their active accounts have grown. This has been growing steadily. I think that’s good.

Here’s how many hours those account holders have streamed. This has been growing steadily. I think that’s good.

And here’s the Average Revenue Per User (ARPU). This has been trailing off. I think that’s bad.

This is very simplistic, I know. But it gets to my point, bear with me a moment longer.

The “headline” results have not been good for Roku. Using Q2 of 2021 as a starting point, the big important numbers have been on bad trajectories. Roku’s year-over-year revenue growth in that quarter was 81%. It has decreased in every quarter since and was only 1% in the most recent quarter. Not great.

Gross margin has also headed in the wrong direction, dropping by around 7 percentage points. It’s the same story for the bottom line. Net income in Q2 of 2021 was $75 million. In the most recent quarter, Roku posted a net loss of $194 million.

When I look at all this, I want to sell. Everything is heading in the wrong direction.

But…

I like my Roku TV, my friends like their Roku TVs, and they’re still growing users and those users are watching more streaming. I feel like they can figure this out and turn things around. Or not. And that’s exactly what brings me to the point of having enough conviction not to sell. I want to see if the company can get back on track. And I’ll be holding my shares at least a bit longer to try and find out.

I’d love for you to tell me how I’m wrong (I know Jason will), so please do so in the comments section.

Thanks for reading!

Jeff

Note: This ain’t personal financial advice. Make your own decisions and own the outcomes.