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Apr 10, 2024

1Q24 Quarterly Investment Review

Christina Siegel Malbon

Strategy Highlights

During the first quarter of 2024, the Patient Opportunity Equity Strategy generated a total return of 11.8% net of fees. In comparison, the Strategy’s unmanaged benchmark, the S&P 500 Index, returned 10.6%.

Using a three-factor performance attribution model, selection and allocation effects contributed to the portfolio’s outperformance which are partially offset by interaction effects. Meta Platforms Inc. (META), Nvidia Corp. (NVDA), Citigroup Inc. (C), Crocs Inc. (CROX), and Inc. (AMZN) were the largest contributors to performance, while Expedia Group Inc. (EXPE), Peloton Interactive Inc. (PTON), Sofi Technologies Inc. (SOFI), Biogen Inc. (BIIB), and Kosmos Energy Ltd (KOS) were the largest detractors.

Relative to the index, the strategy was overweight in the Consumer Discretionary, Communication Services, Financials, Energy, Health Care, and Industrials sectors on average during the quarter. With zero allocation to Real Estate, Utilities, and Consumer Staples, the strategy was underweight in these sectors along with the Information Technology, and Materials sectors.

The representative account portfolio added two positions, Biogen Inc. (BIIB) and Nvidia Corp. (NVDA), and eliminated three positions, Cleveland-Cliffs Inc. (CLF), Coinbase Global 3.375% Notes Due 2028, and 2U Inc Convertible Notes due 2025, during the quarter. The portfolio ended the quarter with 40 holdings where the top 10 stocks represented 49% of total assets compared to 32.2% for the index, highlighting the fund’s meaningful active share of around 98.0%.

Portfolio Review

The headlines continued to focus on the dominance of the Magnificent 7 in the quarter. The largest names continued to perform well, and we benefited from having exposure in names that we continue to find attractive like Alphabet Inc. (GOOGL), Meta Platforms Inc. (META), Inc. (AMZN) and Nvidia Corp. (NVDA).

While much has been made about the “bubble” in these names, we tend to disagree. Looking at the underlying fundamentals, these are some of the best companies in the world. As a group, they had an average revenue, earnings per share (EPS) and free cash flow (FCF) compound annual growth rate of 24%, 33%, and 41% respectively over the last decade. Additionally, their return on invested capital more than doubled. 

From where we sit today for the names we own, expectations do not appear demanding. Alphabet looks to be pricing in a revenue compound annual growth rate (CAGR) of 4% over a 20yr period at current margins, barely above inflation.’s valuation implies topline growth over 20 years of 7% assuming they reach long-term margins of 12% over that time period. This seems low considering we are still in the early transition of e-commerce and cloud workload migrations. Meta Platforms assumes growth of 7% over a 20-year period at current margins, in-line with near-term estimates of digital advertising growth. Finally, Nvidia is pricing in growth of 15% over a 20-year period (which drops to 12% if you look at the growth off of FY25 instead of FY24s). Currently, we think Nvidia has more similarities to Microsoft than Cisco. 

All together, these are hardly bubble type expectations. 

This quarter we benefited from our exposure in the cryptocurrency space. The approval of 11 new spot Bitcoin ETFs dramatically opened Bitcoin to new investors for the first time. Investors’ interest was material, with assets under management growing to $55B over a single quarter. Coinbase Global Inc. (COIN) was a beneficiary of these events as we believe it is building the foundation of the crypto-ecosystem. We continue to believe COIN has the potential to be the platform for crypto as it has continued to widen its moat by investing throughout the most recent crypto winter.

New and Eliminated

This quarter we entered two new positions, while exiting four positions. Our first new position was Nvidia Corp. (NVDA), which we bought early in the quarter. Nvidia is the market leader in designing and selling Graphics Processing Units (GPU), which has recently benefited from the insatiable demand of artificial intelligence (AI) models. The company currently captures 92% market share of data center GPUs and grew revenue, earnings and FCF an astounding 126%, 392%, and 610%, respectively, over the last year. While much of the focus is on Nvidia’s market cap reaching $2.3T, up 230% over the last year, the company’s valuation has actually come down over that period. As of 3/31/23, consensus was valuing the company at 61x forward EPS. This compares to today, where the company is being valued at 37x. While yes, we have never seen a company expand their market cap by so much so quickly, we have also never seen a company grow their fundamental earnings and cash generation so quickly (and which is actually expanding faster than valuation). While competitors are working to enter the GPU space, Nvidia has created a moat around their GPUs with their CUDA software offering. While we do expect the large cloud players to continue to move into the market, we think NVDA can continue to demand top market share. With leading edge technology, an increasing innovation cycle and strong cash generation, the company is well positioned for the increased adoption of accelerated computing and artificial intelligence (AI). 

 We started a position in Biogen Inc. (BIIB) during the quarter, a global biopharmaceutical company focused on multiple sclerosis, spinal muscular atrophy, and most recently Alzheimer’s disease. The company has been on a roller coast since the approval of Aduhelm, for the treatment of Alzheimer’s disease, in June 2021. At the time, the approval was highly criticized given the limited efficacy of the treatment. Following the fallout, the company stands today with a new highly regarded CEO, Christopher Viehbacher, a more efficacious approved Alzheimer’s treatment in Leqembi, a rationalized cost structure and a more disciplined investment approach. While the uptake in Leqembi has been slow, we still see strong long-term potential for a patient population that is dramatically underserved. We believe you are getting the opportunity to buy a high performing health care asset, with a strong track record of delivering superior products all while only paying for the current value of their assets on the market today. At the current valuation, we think you are getting a call option on the pipeline and the Leqembi roll-out. It is not often that you see this sort of risk/reward skew in the market, and we opportunistically took advantage. 

We used Cleveland-Cliffs Inc. (CLF) and Coinbase Global Inc. 3.375% due 2028 as funding sources in the quarter. We exited 2U Inc. 2.25% Convertible Notes due 2025 during the quarter.

Top Contributors and Top Detractors

Top Contributors Ticker Net Contribution (bps)
Meta Platforms Inc. META 151
Nvidia Corp. NVDA 133
Citigroup Inc. C 131
Crocs Inc. CROX 123 Inc. AMZN 118
Top Detractors Ticker Net Contribution (bps)
Expedia Group Inc. EXPE -72
Peloton Interactive Inc. PTON -66
Sofi Technologies Inc. SOFI -62
Biogen Inc. BIIB -31
Kosmos Energy Ltd KOS -29

*Contribution illustrated above are provided net of fees and includes cash.

Top Contributors

Meta Platforms Inc. (META) was a top contributor in the first quarter gaining another 37.5%. Performance has been supported by strong top and bottom-line growth as the company maintains its leadership in the advertising space, despite Reels still being under monetized versus Newsfeed and Stories. The company continues to return cash to shareholders, increasing their buyback program by another $50B in February (6.4% of shares outstanding), and announcing their first dividend of $0.50 per share (0.39% yield). The company trades at 25x this year’s earnings, which we do not view as too demanding for a company with some of the best AI assets, an improving topline that should lead to free cash flow outperformance and continued capital return. 

Nvidia Corp. (NVDA) 
was a top performer in the quarter gaining 82.5% in the period. While the company has had an impressive run, gaining 242% over the last year, the valuation has been supported by the impressive growth in Revenue (126%), EPS (392%) and free cash flow (610%) over the last year. The company has solidified its position in the GPU space supported by its proprietary software CUDA. While we expect competition to increase, we think NVDA can continue to maintain top market share. With leading edge technology, an increasing innovation cycle and strong cash generation, the company is well positioned for the increased adoption of artificial intelligence (AI).

Citigroup Inc. (C)
gained 24.1% in the quarter continuing its uptrend from 4Q. The company is on a multi-year journey to reorganize the business and reach return on tangible common equity of 11-12% by 2026 (and higher further out). Citigroup is finally taking the hard actions necessary, cutting unprofitable departments, taking out middle management layers, and reducing overall headcount. As of early March, the company was 70% done with its business exits and had reduced management layers by 1/4th. We have high confidence Citi will hit its targets. In the meantime, the company is returning cash to shareholders, which could meaningfully increase if the Basel III capital proposal is changed.

Top Detractors

Expedia Group Inc. (EXPE) experienced a digestion period in the first quarter, declining 9.3% and giving back some of its gains from its very strong fourth quarter. The company entered 2024 with a clean slate having successfully completed their tech transition, rolled out their unified loyalty program, and began to reinvest advertising dollars. With the initiation of a $5B buyback program in November (26% of shares outstanding), the company continues to focus on returning cash to shareholders, buying back 11% of shares over the last year. As the company continues to execute, we believe the market will eventually give them credit for their improved fundamentals.

Peloton Interactive Inc. (PTON) 
declined in the first quarter, hitting its lowest per share valuation in late March since becoming a public company. The company has taken drastic action to right-size the extremely bloated cost structure, expand sales channels (Amazon, Dick’s Sporting Goods), and test other ways to reinvigorate growth. The company is hyper focused on reaching positive free cash flow generation, but the path was pushed out. We continue to believe the value of the business lives in the high-margin, sticky subscription piece of the business. We think at current valuation, the company will either successfully turn things around or be a take-out target. 

Sofi Technologies Inc. (SOFI) 
fell in the first quarter despite delivering strong 4Q results and 2024 guidance supported by their non-lending businesses. The company continues to gain share in the digital lending and neo-banking space, consistently growing deposits at $2B a quarter. What differentiates the company is their focus on prime and super-prime customers (average FICO 749). Sofi is early in its life cycle, currently being a small player in a very large total addressable market (TAM). With their strong management team, we believe the company will continue to deliver on their guidance of strong growth and expanding margins.

1Q24 Opp Equity NOF Attribution
Market Proxy is S&P 500. Returns greater than 1 year are annualized. Source: Bloomberg and Patient Capital Management

The data provided is from APX and Patient Capital Management, LLC and is believed to be reliable, but is not guaranteed as to its timeliness or accuracy. Percentages and returns may not sum to 100% due to rounding effects. A three-factor attribution consists of the allocation effect, selection effect, and the interaction effect, which sum to the portfolio's performance relative to the benchmark. 
Allocation. The allocation effect represents the portion of the portfolio's excess return attributable to differences in sector weights between the portfolio and the benchmark index.
Selection. The selection effect represents the portion of the portfolio's excess return attributable to differences in the weights of individual securities within each sector between the portfolio and the benchmark index.
Interaction. Most complex and sometimes counterintuitive, the interaction effect represents the portion of the portfolio’s excess return attributable to combining sector allocation decisions with security selection decisions, and is often thought of as measuring the accuracy of manager’s convictions.

Please note that the methodology used by our independent third-party attribution software vendor will at times present sector allocation effects that are counterintuitive. For example, the software may calculate a negative sector effect even when the portfolio, on a weighted average basis for the period, was overweight an outperforming sector. Under the vendor's methodology, allocation effects in recent months may overwhelm the allocation effects from earlier in the period, particularly over longer time frames.

Returns illustrated above are provided net of fees and include cash. Total portfolio return figures provided above reflect the sum of the returns of the holdings in the representative account portfolio due to price movements and dividend payments or other sources of income.

Related Articles:
Samantha McLemore's Q1 Commentary

The S&P 500 Index is a market capitalization-weighted index of 500 widely held common stocks. Investors cannot invest directly in an index and unmanaged index returns do not reflect any fees, expenses or sales charges. Magnificent 7 is a group of stocks made up of mega-cap stocks Apple (AAPL), Alphabet (GOOGL), Microsoft (MSFT), (AMZN), Meta Platforms (META), Tesla (TSLA) and Nvidia (NVDA). Earnings per share (EPS) is a company's net income subtracted by preferred dividends and then divided by the average number of common shares outstanding. Free cash flow (FCF) is the cash a company generates after taking into consideration cash outflows that support its operations and maintain its capital assets. Compound annual growth rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer than one year. Graphics processing units (GPU) is a specialized electronic circuit initially designed to accelerate computer graphics and image processing. Lecanemab (Leqembi) is an antibody intravenous (IV) infusion therapy that targets and removes beta-amyloid from the brain.

This information does not constitute, and should not be construed as, investment advice or recommendations with respect to the securities and sectors listed. All investments are subject to risk, including the possible loss of principal. There is no guarantee investment objectives will be met. Neither Patient Capital Management, LLC, nor its information providers are responsible for any damages or losses arising from any use of this information.

The Opportunity Equity composite performance figures reflected above include the deduction of a model investment management fee of 1% (the highest fee for separate accounts under our fee schedule), paid quarterly and certain other expenses. For important information about Opportunity Equity Strategy performance, please click on the Opportunity Equity Strategy Composite Performance Disclosure. Past performance is no guarantee of future results.

All holdings and portfolio data are reflective of a representative Opportunity Equity account.

Performance in attribution table is not official strategy returns. The return is sourced from APX and is net of fees based on the strategy’s representative account.

Contributors detailed above represent the top five securities that contributed positively to performance during the quarter. Detractors detailed above represent the top five securities that detracted from performance during the quarter. Information detailed above is provided net of fees, includes cash, and is based on a representative Opportunity Equity account. Contribution listed above represents the period when the security was held during the quarter. For additional information on how Top Contributors and Top Detractors were determined and/or to obtain a list showing every holding’s contribution to the representative Opportunity Equity account performance contact us.

The information presented should not be considered a recommendation to purchase or sell any security and should not be relied upon as investment advice. It should not be assumed that any purchase or sale decisions will be profitable or will equal the performance of any security mentioned. References to specific securities are for illustrative purposes only. Portfolio composition is shown as of a point in time and is subject to change without notice.

The views expressed in this commentary reflect those of Patient Capital Management analyst(s) as of the date of the commentary. Any views are subject to change at any time based on market or other conditions, and Patient Capital Management disclaims any responsibility to update such views. The information presented should not be considered a recommendation to purchase or sell any security and should not be relied upon as investment advice. It should not be assumed that any purchase or sale decisions will be profitable or will equal the performance of any security mentioned. Past performance is no guarantee of future results.

Click for the Opportunity Equity Strategy Composite Performance Disclosure.

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