LB Thinking Podcast: As the growth outlook changes, so should your portfolio.

Welcome to Left Brain Thinking, where creative investment ideas meet logical analysis. That's the hallmark of Left Brain Investment Research, where the analysts are looking for growth companies with the potential to double in 2 to 3 years and high-yield bonds with the potential for dramatic price appreciation. Today, Brian Dress, Director of Research for Left Brain Investment Research, is here to discuss what he and the firm are doing in conditions that are changing dramatically for growth stocks. Uh, if you wanna learn more about Brian and the firm and It's thinking now. You go to leftbrainir.com. They're on Twitter at Left Brain IR. Brian Dress, great to chat with you again.

Chuck, as always, good to be with you and the Left Brain Thinkers.

Brian, we may still see reasonable growth, but not the kind of growth we have been forecasting and experiencing for the last year or two. So what does that do for you? You guys are growth stock investors. You're always looking for growth. But if it's not there, or it's not there the way you like it to be there, what happens then?

Well, Chuck, you know, there are a number of crosscurrents going on. I think we're aware of most of them. You know, there are inflation concerns. The Fed is starting to move their expectations of higher interest rates. And we're also seeing a lot of tax loss selling in the growth stocks that were the darlings of 2020. So things are changing, and we're starting to make some changes as well to respond to those changes. You know, we're always looking for growth, as you said, but it's been skewing toward tech for the last few years. That's where the growth has been. But, you know, we always caution investors to understand we're not just tech investors, we're growth investors. So we're starting to look for different ways to find growth and also sort of de-risking portfolios by clipping off some of the weaker holdings that are more dependent on future profits and looking toward companies that have profits in the current day. We think that's going to be a better way for investors to proceed over the next few months into 2022.

When I talk with value investors, they will talk about are they relative value investors or the absolute value investors. The difference, for anybody who's not aware, is that a relative value investor says, hey, I'm going to be fully invested in all conditions. If the values aren't as compelling as they might like in other conditions, well, I'm still going to buy the best that's out there. The absolute person, if they can't find what they like that meets their metric, they go to cash. With a growth investor, you could go to those high-yield bonds that you like, but they're few and far between too right now. So what does it put you into in terms of portfolio construction?

So we're still going to hold on to growth, and we're going to skew again toward companies that have current profits. What's really happening in the market is With interest rates going higher, a lot of investors use the dividend discount model or some other sort of discount model that depends on interest rates as an input. So what happened in, in the past was with low interest rates, companies with future profits and current negative earnings were evaluated at a higher premium than companies that had current profits. So as interest rates continue to rise or may rise in the future, what we're seeing is companies that have current profitability are starting to be valued more by the market. So what we have been saying is that companies with really high multiples and negative earnings, I think it makes sense to sort of trim up those positions and start looking into other sectors. The first is mega-cap tech. So you still have growth in sort of the FAANG names and Apple and companies like that, but they have also earnings. That's one way to go. But we're also starting to look at a few other sectors. One is financials. Insurance companies benefit from higher rates because they have the float. Companies that collect premiums and deposits and invest in higher yield instruments are going to benefit from a different interest rate environment that we might be having. Looking at companies that are in the healthcare space, which is traditionally defensive, and also these are companies that are profitable with pricing power. And then also energy, which is an inflation hedge, especially like large integrated names with strong balance sheets. In low breakeven prices. You know, so we're basically looking for companies where there might be some growth, but also looking at companies that have been shunned over the last few years in lieu of tech that has really taken off. So we're looking for opportunities where we can not only get that earnings growth, but also multiple expansion and kind of depend on growth through that lens.

Is there any sign you'll be looking for that will get you back to the bigger, faster hypergrowth names? What has to change? And is it at the company level, which is where you're normally looking, or is it at the market and economy level? I mean, if we could get numbers on inflation that would calm down, would that potentially change what you're looking at?

So it's hard to say it's on the company level because we just came out of earnings season. We saw a lot of the companies that we traditionally favor having done quite well, a lot of beats and raises that were met actually with selling. And so it's going to be difficult to look to the company level because if the market's going to respond that way, it's going to be very difficult to expect better company news to change the dynamics. So that's, that's not what we're going to be looking for. What we're going to be looking for is, first of all, we're not going to try to bottom pick. You know, a lot of these companies are trading, we're talking about 10 to 20 times sales. These hypergrowth companies. So you have to be willing to understand that they've got a long way to fall, potentially. Not necessarily forecasting that's the case, but you really have to de-risk and understand what risk you're holding in a portfolio. So what we're looking for, you know, we always talk about not only fundamentals but technicals. We're looking for markets and for those type of stocks to start acting better. So we want to see some confirmation that institutions are back, buying. And part of that's going to be stop seeing these companies close on the lows. And also, we've been seeing a number of these days where these stocks have gapped up at the open and have been sold heavily at the open and down at the end of the day. We need to see an end to that dynamic. We'd rather miss a little bit of the move higher and wait for that confirmation that institutional buyers are back into these names before we really start jumping in. Once again to take advantage of these hypergrowth companies. They are high-quality companies, but the market's telling us something, and that's that future profits just don't have the same value as they had, you know, a few months ago. So like I said, we're not going to be trying to jump in, catch the very beginning of these moves. We want to see some confirmation from a technical point of view and from sort of a quantitative and an institutional buying point of view before we sound the all clear. Some of these companies that are really quality businesses but just falling out of favor in the current situation.

How much and how frequently do you add some of the technicals in to your analysis? I mean, if you find the right growth metrics, technicals don't matter as much to you, but how do you blend those two normally? And are you doing more of it in these conditions?

I think it's just times of trouble, you have to look more to the technicals because like I said, When these companies carry such premium valuations, you have so far to fall. So you gotta get ahead of things. And if you see some of that valuation starting to chip away, that's when we start looking a little bit away from the fundamentals and more toward the technicals, because we understand that other market participants are looking at the same concepts in, in terms of technical analysis. And when some of these stocks break, they really break hard. And we don't want to be sitting here holding onto broken growth stories because it might take a couple of years for them to come back together again. If you look back into the 2000s decade, you know, after Y2K, take a look at some of the tech names and some of the really hypergrowth names. It took them many years to come back into favor. It doesn't make sense to just look only at the fundamentals. If a certain sector or, you know, hypergrowth type of stocks are going to be out of favor. We don't wanna sit there and, and disregard market signals.

Some people worry a lot about selling, and I know that you guys, you don't worry about churn. You don't worry about, hey, we've gotta turn things over. So explain a little bit there. You were just getting it at some of it, like, hey, I don't wanna be in something that may take a long time to get healthy, but why don't you worry about turnover and churn in a portfolio where so many individual investors just kind of are antsy about You know, we always say it's smart to take a look at kind of your bottom 20% of your holdings.

You know, looking at your holdings on a continuum. Okay, I like this stock, my number 1 favorite stock, all the way down to my number 30 favorite stock. You know, I think it makes a lot of sense to look at that bottom 20% and decide, okay, if I need to raise cash or I want to shift into something else, this is a good opportunity, or these are good candidates for raising that cash or creating that capital. We like the stocks that we hold, but everything has room for improvement. So it's definitely going to do better if you're an active manager to take a look at a few of the stocks that you think might not do well over the next few years, clip those from the portfolio, put them on a watch list, and then when conditions get better, take a look at maybe getting back into them. But it doesn't make sense to sit in a sector of stocks that might really struggle for the next few years if there's an opportunity to shift over to something like financials, healthcare, energy. Where we think money might be flowing over the next couple of years.

Brian, great stuff. Thank you as always. Have a great holiday season. Look forward to talking with you again in 2022.

Thanks so much, Chuck. Talk to you soon.

Left Brain Thinking is a joint production of Left Brain Investment Research and MoneyLife with Chuck Jaffe. Our conversations are not personalized investment recommendations, but are designed to engage your brain. Please do your diligence before making any financial transaction. I'm your host, Chuck Jaffe, and you can learn more about my hour-long weekday podcast at moneylifeshow.com or on your favorite podcast app. Thanks to my guest, Brian Dress, Director of Research at Left Brain Investment Research. Learn more about the firm at leftbrainir.com and sign up there for the Jarvis newsletter, which highlights the insights gained from the outputs of Jarvis, the firm's proprietary research system. If you want to look into Left Brain's new mutual fund, Details are available at leftbrainfunds.com, and the firm is on Twitter @LeftBrainIR. Left Brain Thinking is available every other Wednesday. Subscribe by your favorite podcast app, and until we don our left brain thinking caps again, happy holidays, happy new year, and happy investing, everybody.