LB Thinking Podcast: Rising rates, higher inflation are changing the look of 'growth'

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, Nolan Langford, chief executive at Left Brain Investment Research, is back with us, and we're talking about the transition to 2022 and what lies ahead for growth investors this year. You can learn more about Nolan Noland and the firm at leftbrainir.com. Noland Langford, it's great to chat with you. Happy New Year.

Happy New Year, Chuck. It's always good to be here engaging with our listeners and a Happy New Year to everybody.

Well, Noland, first let's talk about what worked in 2021 as the setup for the changes and what lies ahead.

2021 was a very interesting year. Coming off the COVID year in 2020, which was challenging for a lot of investors, but there were certain ideas that did very well in 2020 that benefited from the stay-at-home pandemic, digital transformation, work remotely, accelerating digital awareness, that sort of thing. 2021 was a complete different animal. You know, a lot of businesses that suffered during the pandemic reopened in 2021. And a lot of those businesses got attention. There was acceleration there in their revenues and earnings, not maybe from a 3-year stack, but certainly from a 1-year stack. And those businesses garnered a lot of attention. So 2021 was interesting. At the index level, it looked like the indexes did well. But if you take a look at what was driving it, there were different sectors that drove the 2021 returns. Than what drove the 2020 returns. And here we sit at the beginning of 2022, and there are certain crosscurrents that we have to navigate as investors. So it's challenging, but it's also interesting.

So let's talk about the challenges that lie ahead. It has been something of a transitional year. We're getting used to the idea that interest rates are going up, inflation is back, and it's going to stick with us for a while longer than anybody was thinking it would a year ago. So what is that doing for you in terms of what you're looking towards in the year ahead?

Our Jarvis letter that we produce every week, we laid out a lot of these thoughts. We had a peek into 2022 in our recently released letter. And hopefully for any listeners that are interested, Chuck, you can tell them how to get the letter.

At the end of this talk, I will make sure everybody knows how to check out the Jarvis newsletter.

But what we're looking at, you're right, you hit it. Interest rates are finally on the move. You know, for most listeners that have been investors for some time, I don't think any investor can remember when rates were on the way up. You know, we've been saying it for a couple of decades, eventually they have to go up, and then they went to zero. And then in some countries they went negative, but finally we're on the cusp of rates going up. The inflation thing, which a while back looked like it would be temporary, is starting to look like it's going to be more long-lasting. A lot of it has to do with the supply chains, but not everything. And so that has to be priced differently into the market. You know, if you have companies that are growing revenues, but they don't have reported earnings, meaning that they're not expected to really make cash for several years in the future, if interest rates are very low, then those businesses get a higher multiple because it doesn't cost them much to go out and buy new customers or new sales. They're not missing much because interest rates are low. But once interest rates rise, you have to discount those future cash flows at a higher number, which means they have a lower valuation. So that's one of the things that's happening. And I know for a while there was this growth versus value debate, and a lot of these value investors said, hey, these cheap stocks are good businesses, but the prices are low and they've been low and they're not moving up, and a lot of capital is going into growth businesses. And finally, maybe interest rates and inflation going up is the white flag for investors to sort of rotate. And we're starting to see a rotation. So we're paying attention to areas that we like. I mean, we still are looking for revenue growth. We're still looking for earnings growth. And the big thing that we're looking for is acceleration. We're just looking for it a little bit differently. Businesses that were growing at 7 or 8% that are now growing at 12 or 13%, or earnings were growing at a clip at 10 or 12, but are now growing at 15 to 20%. That's interesting. You can see a lot of appreciation in those businesses, and we're just finding different sectors for companies that meet those profiles.

In the Jarvis newsletter, one of the things that you had was sort of a list of what has been working and what hasn't. It's the fast growers versus realistically the fast shrinkers. And not just from what I was looking at at the newsletter, but like I saw a couple of different guys giving commentary like, hey, these were the best stocks in the S&P 500 and these were the worst. And everybody was taking a look at those lists and go, well, stock number 1, number 4, number 7, those can keep going. And at the bottom list, I think stocks number 500 and 486, those are the ones that are likely turnaround candidates. So for you, when you're reviewing this list of what's been working and what hasn't, how much is it let it ride while the momentum is there but you're ready to pull back because we're seeing a transition? How much of it is the first sign of trouble, the first sign of slowing, we have to change how we think about it.

Every investor has to determine, hey, this is working, this stock is up X amount, and then that's okay. But you don't make money based off of what happened in the past. It's how likely is this to continue and under what circumstances. And I look at our list from the letter, you know, if you take a look at the first two holdings in our database, the stocks that did the best last year. AMC Entertainment, the movie theater house, of course, that was a meme stock, and it appreciated up over 1,200% for the year. And then number 2 on the list is Avis Budget, the rental car company, up 500%. And in both cases, you kind of see that theme play out. You know, in 2020, both businesses were shut in, people weren't traveling, and we weren't going to the movies. And in 2021, we were. We also are looking for persistent and consistent in the business fundamentals. Neither of these would be candidates on our list for 3 or 4 years from now for their businesses being better than they are today. So that's a good example of what you meant. Now, the bottom of our list, which was still up over 100%, there's a business, Bath and Body Works, BBWI is the ticker. That one is one where we do like. The shares were up over 100% last year, but most people aren't familiar because at one point It was part of a conglomerate, L Brands, where Victoria's Secret and Bath Body Works were both businesses under the parent. And then mid-year last year, they both spun off into separate companies. And Bath Body Works up over 100% a year. The shares are still very cheap. They trade at about 15 times earnings. But this is a very healthy business. They're vertically integrated. The body scents, the candles, the hand sanitizers. The store footprint is growing and they're vertically integrated. And so we think now that they're separated from the slower growing Victoria's Secret, which was a more turnaround candidate, this is a prime candidate for us. We think this one does have legs over the next couple of years and is very interesting. So that's sort of our take and how we look at the companies that may have gotten a temporary boost versus one where we think it can keep going.

On that list of things that have been working include stocks that you and I have discussed in the past, like Nvidia. The list also includes a stock like Devon Energy, which we haven't talked about, but which was the number one gainer for the S&P 500 last year, up almost 200%. Now I know that energy, never a great growth business, not the kind of thing that normally attracts you. So when we talk about turning over, it is kind of interesting how many energy, oil, other kinds of stocks were at the top of the S&P this year. Is that part of what you're talking about as well? Is that, hey, you got to look in some areas that you haven't been looking in historically?

Bingo. I think you summarized it well. And I'm going to take you to task a little bit here. When you say, hey, these aren't the type of businesses we typically look at, you know, we're looking for acceleration. Energy is cyclical, that I'll grant you. But energy has been a turnaround candidate. I've written that in Nolan's Notes for, I think, 2 of the last 3 years. One of the things that we take a look at is underperformance versus the S&P, and it's astounding how energy's been left behind for a decade. It really has not done anything. And in 2020, there was a brief time where oil prices went negative. And like they say in the commodity business, one of the things that cures low prices is low prices. So energy prices probably have a band here and a floor, and anything above $50 per barrel, these oil companies are wildly profitable. Unlike in the past when we were building out our energy infrastructure and the oil companies would just drill, drill, drill, borrow money, drill more, and take a big loan out and drill more. They're past that and they've gotten the message. So we're not seeing a lot of these oil and gas rigs and new oil wells come online. Instead, what these producers are doing is taking all that extra cash flow, paying off debt, buying back stock and increasing dividends. So here we do like growth, and here you're getting growth in cash flows, growth in dividends, and as oil prices stay above $60 a barrel, you're also getting growth in revenue. So I think energy— we are looking at energy. Energy is interesting, and I think the, um, you know, the energy story is probably going to be with us for a while. We sort of like the sector.

Nolan, really interesting stuff. I look forward to seeing how it turns out. We'll talk to you again, of course, many times in the year ahead. Look forward to the next conversation already.

Happy New Year, Chuck, and happy New Year to the listeners. Looking forward to revisiting everybody throughout 2022.

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 am Chuck Jaffe, your host, and you can learn all about my hour-long weekday podcast at moneylifeshow.com. Thanks to my guest, Nolan Langford, Chief Executive at Left Brain Investment Research. Go to leftbrainir.com to learn about the firm and to sign up for the Jarvis newsletter that we discussed. It keeps tabs on all of Left Brain's latest research. You can learn about the firm on Twitter at Left Left Brain IR. Left Brain Thinking is available every other Wednesday. Subscribe via your favorite podcast app. And until we don our left brain thinking caps again, happy investing, everybody.