Journal #1: Portfolio Review - Q1 2021

Inaugural investing journal post

In 2021, I plan to share my personal portfolio, performance and lessons learned via this newsletter. I am doing so primarily to aid in my development as an investor, but hope that readers can find value in following my investing journey (and avoid the mistakes I will undoubtedly make).

Before getting into the details of my portfolio, here is more background on me:

I am a 31-year old amateur investor working in corporate America who enjoys analyzing stocks, but admittedly lack professional experience and a real edge as an active manager. I’m not really sure I have what it takes to beat the market, but I enjoy trying because I see it as both an intellectual and psychological challenge. For me, success looks like being able to retire five to ten years earlier than I would have without such focus on the markets.

My interest in the stock market started in high school when I was exposed to investing through my father. An immigrant from Taiwan, my dad came to the United States with not much to his name, but always had a penchant for saving and investing in the stock market. I saw how his financial discipline and time in the markets changed our family’s trajectory, providing me with opportunities he could not dream of growing up in Taiwan (an extremely poor country in the 70’s).

Zippy’s Portfolio and YTD Performance

About 60% of my capital is held in this portfolio outlined below, with the remaining amount in target date retirement funds (via 401k) and Bitcoin. I have several accounts across two brokers so I am using StockMarketEye to track total performance.

As you can see, the portfolio is weighted toward stay at home winners, which definitely made me nervous as interest rates continued to rise during the quarter and the money flowed out of the COVID beneficiaries and into re-opening and value stocks. In mid-February, the portfolio was up +25%, but it tumbled all the way to slightly negative in early March. Luckily, growth stocks rebounded to close out the quarter and we finished +3.5%.

I attempted to hedge my portfolio via options during the quarter, with limited success. In January, I bought VXX calls that expired in mid-February. In March, I purchased ARKK puts. I was too early on the VXX calls and too late on the ARKK puts. I did not have any hedges in place after mid-February and of course that is when I needed that exposure. One thing I realized this quarter is that I need to spend more time figuring out the proper portfolio hedging strategy or not try at all. I am leaning toward not hedging.

Looking ahead to Q2, I anticipate a few major changes to the portfolio. First of all, I need to raise cash in order to make a down payment on a house and plan to sell out of some of my lower conviction names. In addition, I plan trim down by ARKK position to fund purchases of existing stocks in the portfolio.

Stock Comments

At almost 20% of the portfolio, Sea Limited (SE) is my highest conviction holding. The developments in the first quarter of the year only solidified my view on Sea’s upside.

Since January, Sea has: 1) established Sea Capital after acquiring a Hong Kong based investment management firm, 2) acquired an Indonesian bank, 3) opened an Artificial Intelligence lab, 4) launched food delivery in Indonesia, 5) entered the Mexico market with Shopee, 6) achieved #1 shopping app status in Brazil in terms of monthly active users and more. Oh and the company put up amazing Q4 and full year 2020 results (a great summary here).

Moving forward, the biggest question continues to be: when will Sea be able to turn a consistent profit? While Garena is running at ~65% EBTIDA margins, Shopee continues to bleed cash as it in full-on expansion mode. Despite short term losses, I believe Shopee is on the right track.

In a study of marketplace business, Andvari Associates concludes that profitability comes once dominance is established.

Once a company gets to 3–5 times the size of the second player, the EBITDA margins grow above 30%. When a company is 8–10x the size of the second player, margins can be enormous.

The process of establishing dominance takes time and aggressive investment…in the short-term, this spending can translate into a company with subdued margins and expensive-looking earnings multiples.

Shopee is in a dominant position in Taiwan, which is the app’s most profitable market. In Q4 2019, Sea reported that Shopee Taiwan had > 20% EBITDA margins (since then, this rate has improved). In other markets, Shopee is generally either the #1 or #2 player, but they are by no means the clear winner just yet. As Shopee begins to separate from its competitors in these markets, I would expect profitability to improve. In fact, Shopee recently raised take rates in Indonesia from 1.5% to 2.0% (following a 1.0% to 1.5% hike in September 2020).

Certainly, management seems very confident that they “control their own destiny” and could reach profitability today if they wanted to across all geographies:

But most importantly, I think, suffice to say is that, we can breakeven as we choose to at this point, even at this take rate.

And our Taiwan take rate is not -- for example, that's the first market where we broke even and we have achieved a very healthy EBITDA margin there, as we previously disclosed before. And the take rate in Taiwan is not highest, even among our existing market. So it's not to say that we have to drive to a very high take rate to be able to break even. Our investment in growth is really by choice and according to the pace that we think is suitable for each market. So we're in a very good position right now where our destiny is in our own hands, and we can control the pace of investment and allocation of each market in a highly dynamic and elastic way to drive efficient growth.

Gravity (GRVY) was by far my worst performing stock in the 1st quarter of the year, but I still feel positive about the company’s 2021 prospects despite the short term price action. In retrospect, I should have been more patient in building my position.

News flow has been quiet until recently when the company provided more details around upcoming launches at the annual shareholder meeting. In Q2, management expects Origin to launch in Japan, Next Generation to launch in Southeast Asia (via a co-publishing agreement with Bytedance).

We also got an update on the new in-house developed PC MMORPG Ragnarok Begins. The game is currently in a closed beta test and in-game footage is available on Twitter and YouTube. Commentators are saying the game looks better than expected.

Etsy (ETSY) reported a great Q4 and full year 2020 as expected (GMS +118%, Revenue +129%, Adj EBITDA +251%). In addition, they announced massive guidance for Q1 2021 (+125-135% revenue growth). As a result, analyst estimates and price targets were appropriately adjusted higher after the report.

I was very encouraged by Etsy’s international business trends, which actually grew faster than the US business in the quarter. The company invested significantly in UK marketing in Q4 and that spending seems to have paid off as Etsy is now a top 5 e-commerce site there. Furthermore, Etsy is now considering India as a “core market”.

I will end this post with a quick introduction of RCI Hospitality (RICK), a new position I added to the portfolio beginning in January.

RCI is small-cap holding company that runs over three dozen strip clubs and a fast growing sports bar / breastaurant chain called Bombshell’s - currently with ten locations. The majority of RCI’s properties are located in Texas, but they also run top gentlemen’s clubs in various cities outside of the Lone Star State.

Why invest in a strip club company? Not only is RICK a great re-opening trade, but the company has a large market opportunity to go after and it is protected from competition (with the help of the government). Furthermore, RCI Hospitality boasts a management team with skin in the game and discipline around how they allocate capital.

RCI management estimates that there are 2,200 gentlemen’s clubs in the United States that RCI would consider to acquire. Many of these clubs have a sustained history of strong cash-flow generation and owners looking to retire in the coming years. As a result, RCI should have a healthy M&A pipeline. In regards to the Bombshell’s sports bar concept, RCI sees potential for 80-100 locations - and the company is beginning to set up franchising agreements (which shareholders should welcome given the steady cash from royalties but limited capital expenditures).

The barriers to entry in the gentlemen’s club business is quite high due to government regulation. Typically, local governments are typically not granting new operating licenses for adult businesses for a variety of reasons, so existing strip clubs are largely protected from new competition. RCI’s clubs are typically the “go-to” clubs in their respective cities and because new clubs are not expected to be popping up, RCI’s locations will enjoy and sustain their top tier status over time. Lastly, when it comes to acquiring existing clubs, RCI is often the “buyer of choice” as they have the resources and financing to offer terms that are hard to match. When RCI is bidding for a club, they are typically going up against groups that simply cannot offer same terms.

CEO Eric Langan owns 8% of the company and newly promoted CFO Bradley Chay has made purchases recently. Not only does management have significant equity in the company, but Langan has a disciplined framework on how to deploy capital. Take a look at RCI’s approach below…many large cap companies could take some notes: