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The Long Term Investor

Discussion in 'Investing' started by WXYZ, Oct 2, 2018.

  1. TomB16

    TomB16 Well-Known Member

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    The system that preys on traders has become as big as the system of public corporate ownership.

    NASDAQ makes a strong majority of it's income from colocations and those guys aren't in the most expensive data centers in the world for convenience.

    Stock trading is like Las Vegas. Everyone makes money while new billion dollar casinos proliferate. It's the only true perpetual motion in the universe.
     
  2. WXYZ

    WXYZ Well-Known Member

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    For those interested in Robinhood and their sales of their........supposed customers.......data to the High Frequency Trading firms.......here is an interesting article from the latest issue of Forbes. I saw this article a while back since I subscribe to Forbes. This sort of "stuff"raises the question..........who is actually the customer here?

    The Inside Story Of Robinhood’s Billionaire Founders, Option Kid Cowboys And The Wall Street Sharks That Feed On Them

    https://www.forbes.com/sites/jeffka...street-sharks-that-feed-on-them/#84cf6b9268dc

    (BOLD is my opinion OR what I consider important content) (story has been edited some by me, see article for full content)

    "It’s just after midnight on Friday, July 31, and the Todd Capital Options Community, a $20-per-month subscription Slack channel favored by thousands of novice options traders, is buzzing with life. Unemployment is soaring and governments worldwide are desperately trying to fend off economic collapse. But members of this online enclave are partying, quite literally, like it’s 1999—the infamously frothy day-trading year before the dot-com bubble burst in March 2000.

    Despite the pandemic, Amazon, Apple, Facebook and Google have just released jaw-dropping financial results, a staggering $205 billion in combined quarterly sales and $34 billion in earnings during a stretch when U.S. gross domestic product plunged at an annualized rate of 33%. For weeks, the club’s youthful members have been loading up on speculative call options using the mobile trading app Robinhood. Now they’re ready to cash in.

    “Literally, NOTHING will make me sell my AMZN 10/16 calls tomorrow. I don’t care what happens. . . . I’m holding everything. Keep ya boi in your prayers,” says one user named JG. As dawn approaches, “NBA Young Bull” announces: “Good morning future millionaires . . . is it 9:30 yet?”

    For these speculators, the adrenaline rush turned to euphoria after Apple not only beat earnings expectations but announced a 4-for-1 stock split, luring more small investors to the iPhone maker’s stock party. At 9:30 a.m. Friday, when trading begins, the call options on Apple and Amazon held by many of these market newbies pay out like Las Vegas slot machines hitting 7-7-7 as both tech giants gain a collective quarter-trillion dollars in market value. Throughout the day and over the weekend, a stream of posts scroll by from exuberant Robinhood traders going by screen names like “See Profit Take Profit” and “My Options Give Me Options.” On Monday, August 3, the Nasdaq index sets a new record high. (see Robinhood Returns below)

    Welcome to the stock market, Robinhood-style. Since February, as the global economy collapsed under the weight of the coronavirus pandemic, millions of novices, armed with $1,200 stimulus checks and nothing much to do, have begun trading via Silicon Valley upstart Robinhood—the phone-friendly discount brokerage founded in 2013 by Vladimir Tenev, 33, and Baiju Bhatt, 35.

    The young entrepreneurs built their rocketship by applying the formula Facebook made famous: Their app was free, easy to use and addictive. And Robinhood—named for the legendary medieval outlaw who took from the rich and gave to the poor—had a mission even the most woke, capitalism-weary Millennial could get behind: to “democratize finance for all.”

    Lord of the Buys
    The Covid bull market has been a godsend for retail brokers, but Robinhood and its swarm of newbie traders is schooling the competition.
    [​IMG]
    Source: Piper Sandler

    Like any skilled trader, Tenev is talking his book. His proclamations ring a bit hollow, though, once you look more closely at what is actually driving his digital casino. From its inception, Robinhood was designed to profit by selling its customers’ trading data to the very sharks on Wall Street who have spent decades—and made billions—outmaneuvering investors. In fact, an analysis reveals that the more risk Robinhood’s customers take in their hyperactive trading accounts, the more the Silicon Valley startup profits from the whales it sells their orders to. And while Robinhood’s successful recruitment of inexperienced young traders may have inadvertently minted a few new millionaires riding the debt-fueled bull market, it is also deluding an entire generation into believing that trading options successfully is as easy as leveling up on a video game.

    Stock options are contracts to buy or sell underlying shares of stocks for a set price over a specified period of time, typically at a fraction of the cost. Given their complexity, options trading has long been the realm of the most sophisticated hedge funds. In 1973, three Ph.D.s—Fisher Black, Myron Scholes and Robert Merton—developed an options pricing model that eventually won them the Nobel Prize in economics. Today their mathematical model, and variations of it, are easily incorporated in trading software so that setting up complicated—and risky—trades is no more than a few clicks away. Even so, making wrong bets is easy. According to the Options Clearing Corporation, more than 20% of all options contracts expire worthless versus 6% “in the money.”

    Robinhood has sold the world a story of helping the little guy that is the opposite of its actual business model.

    The problem is that Robinhood has sold the world a story of helping the little guy that is the opposite of its actual business model: selling the little guy to rich market operators with very sharp elbows.

    The rise of Vladimir Tenev and Baiju Bhatt is a familiar one in the era of technology disruption.

    They met as undergrads at Stanford University in the summer of 2005. “We had some astounding parallels in our lives,” Bhatt tells Forbes. “We were both only children, we had both grown up in Virginia, we were both studying physics at Stanford, and we were both children of immigrants because our parents were studying Ph.D.s.” Tenev’s family emigrated from Bulgaria, Bhatt’s from India.

    Tenev, the son of two World Bank staffers, enrolled in UCLA’s math Ph.D. program but dropped out in 2011 to join Bhatt and build software for high-frequency traders. That was shortly after Wall Street’s 2010 “Flash Crash,” a sudden, near-1,000-point plunge in the Dow Jones Industrial Average at the hands of high-speed traders. The extreme volatility exposed how financial markets had mostly moved away from the staid, but stable, New York Stock Exchange and to a smattering of opaque quantitative trading pools dominated by a handful of secretive firms. These so-called “Flash Boys,” who worked milliseconds ahead of orders from both retail and institutional investors, had emerged from lower Manhattan’s back offices and IT departments, as well as university Ph.D. programs, to become the new kings of Wall Street.

    At the same time Tenev and Bhatt were getting an insider’s education in how high-frequency traders operate and profit, the outside world was in turmoil, recovering slowly from the battering of the 2008–2009 financial crisis. It all played into the official Robinhood creation story: When the 2011 Occupy Wall Street movement materialized as a protest of bailouts on Wall Street and foreclosures on Main Street, one of Tenev and Bhatt’s friends accused them of profiteering from an unequal system. Soul searching led the pair in 2012 to conceive Robinhood, a trading app with a name that was an explicit reference to leveling the playing field. The most obvious—and disruptive—innovation: no commissions and no minimum balances, at a time when even low-cost rivals like E-Trade and TD Ameritrade made billions on such fees.

    Initially, Tenev and Bhatt used the allure of exclusivity to capture interest. For their 2013 launch, they restricted access, building up a 50,000-person waiting list. Then they turned the velvet rope into a game, telling prospective users they could move up the waitlist by referring friends. By the time they launched on Apple’s App Store in 2014, Robinhood had a waitlist of 1 million users. They had spent virtually nothing on marketing.

    Bhatt focused maniacally on app design, trying to make Robinhood “dead simple” to use. iPhones flashed with animations and vibrated when users bought stocks. Every time Bhatt came up with a new feature, he’d run across the street with staffers from Robinhood’s Palo Alto office to Stanford’s campus, approaching random students, asking for feedback. The app won an Apple Design award in 2015, a prize given to just 12 apps that year. Millennial customers started downloading it in droves.

    By the fall of 2019, Robinhood had raised nearly $1 billion in funding and swelled to a $7.6 billion valuation, with 500 employees and 6 million users. Tenev and Bhatt, both minority owners of Robinhood with estimated 10%-plus stakes, were rich.

    Flow Rider
    Robinhood's entire business is built on selling its customers’ orders to trading titans like Citadel Securities. At Schwab, so-called PFOF or “payment for order flow” only accounts for 3% of revenues. ETrade, 17%.
    [​IMG]
    Sources: Regulatory filings and industry experts.

    The secret sauce of Robinhood’s success is something its founders are loath to publicize: From the beginning, Robinhood staked its profitability on something known as “payment for order flow,” or PFOF.

    Instead of taking fees on the front end in the form of commissions, Tenev and Bhatt would make money behind the scenes, selling their trades to so-called market makers—large, sophisticated quantitative-trading firms like Citadel Securities, Two Sigma Securities, Susquehanna International Group and Virtu Financial. The big firms would feed Robinhood customer orders into their algorithms and seek to profit executing the trades by shaving small fractions off bid and offer prices.

    Robinhood didn’t invent this selling of orders—E-Trade, for example, earned about $200 million in 2019 through the practice. Unlike most of its competitors, though, Robinhood charges the quants a percentage of the spread on each trade it sells, versus a fixed amount. So when there is a large gap between the bid and asked price, everyone wins—except the customer. Moreover, since Robinhood’s customers tend to trade small quantities of stocks, they are less likely to move markets and are thus lower-risk for the big quants running their models. In the first quarter of 2020, 70% of the firm’s $130 million in revenue was derived from selling its order flow. In the second quarter, Robinhood’s PFOF doubled to $180 million.

    Given Tenev and Bhatt’s history in the high-frequency trading business, it’s no surprise that they cleverly built their firm around attracting the type of account that would be most desirable to their Wall Street trading-firm clients. What kind of traders make the most saleable chum for giant sharks? Those who chase volatile momentum stocks, caring little about the size of spreads, and those who speculate with options. So Robinhood’s app was designed to appeal to the video-game generation of young, inexperienced investors.

    Options Trades are Prime Steak for Robinhood’s real customers, the Algorithmic Quant Traders.

    Besides being given one share of a low-priced stock to start you on your investing journey, one of the first things you notice when you begin trading stocks on Robinhood and are authorized to trade options is that the bright orange button right above BUY on your phone screen says TRADE OPTIONS. Options are sexier than stocks because, like hitting a single number on a roulette wheel, they can offer more bang for the buck.

    Options trades also happen to be prime steak for Robinhood’s real customers, the algorithmic quant traders. According to a recent report by Piper Sandler, Robinhood gets paid—by the quants—58 cents per 100 shares for options contracts versus only 17 cents per 100 for equities. Options are less liquid than stocks and tend to trade at higher spreads. While the company says only 12% of its customers trade options, those trades accounted for 62% of Robinhood’s order-flow revenues in the first half of 2020.

    The most delectable of these options trades, according to Paul Rowady of Alphacution, may very well be so-called “Stop Loss Limit Orders,” which give buyers the opportunity to set automatic price triggers that close their positions in an effort either to protect profits or limit losses. In October 2019, Robinhood gleefully announced to its customers, “Options Stop Limit Orders Are Here,” a nifty feature which essentially puts trading on autopilot.

    That [stop limit] order is immediately sold to a high-speed trader who now knows where your intention is, where you would sell,” says one former high-speed trader. “It’s like you’re writing a secret on a piece of paper and handing it to your broker, who sells it to someone who has an interest to trade against you.”

    Robinhood refutes the notion that its model preys on inexperienced investors and claims most of its customers use a buy and hold strategy. “Receipt of payment for order flow is a common, legal and regulated industry business practice,” says a Robinhood spokesperson who insists the app helped customers save $1 billion on trades this year. “We are focused on providing a platform that makes finance accessible and approachable and where people can make thoughtful, informed investing decisions.”

    Billionaire competitor Thomas Peterffy, the founder of Interactive Brokers, says stop limit orders are the most valuable orders a sophisticated trader can buy. “If people send you orders, you see what they are. You can plot them up along a price axis and see how many buy and sell orders you have at each of those prices,” he says.

    For instance, if a buyer sees sell orders bunched up around a certain price, it means that if the stock or option hits that price, the market is going to fall hard. “If you are a trader, it’s good for you if you can trigger the stop—you can go short and trigger the stop, and then cover much lower,” Peterffy says. “It’s an old technique.” "

    MY COMMENT

    I have edited out some of the article that is not relevant to this discussion. HERE.......to me is the GUTS.....of the article and a WARNING to anyone:

    That [stop limit] order is immediately sold to a high-speed trader who now knows where your intention is, where you would sell,” says one former high-speed trader. “It’s like you’re writing a secret on a piece of paper and handing it to your broker, who sells it to someone who has an interest to trade against you.”

    and

    "stop limit orders are the most valuable orders a sophisticated trader can buy. “If people send you orders, you see what they are. You can plot them up along a price axis and see how many buy and sell orders you have at each of those prices,” he says.

    For instance, if a buyer sees sell orders bunched up around a certain price, it means that if the stock or option hits that price, the market is going to fall hard. “If you are a trader, it’s good for you if you can trigger the stop—you can go short and trigger the stop, and then cover much lower,” Peterffy says. “It’s an old technique.” "

    NO ONE is saying anything here is ILLEGAL.......it is simply BUSINESS. AND......many.......if not most.......Robinhood customers probably dont care. BUT.......myself.......I prefer to know if I am the.....CUSTOMER.....or the.....PRODUCT.



     
    #2082 WXYZ, Sep 15, 2020
    Last edited: Sep 15, 2020
  3. TomB16

    TomB16 Well-Known Member

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    James wang of ARK Invest gives the Nvidea/ARM merger a 50% chance of getting regulatory approval.
     
  4. roadtonowhere08

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    Not sure how this NVIDIA buyout is any more anti-competitive than many other recent mergers.

    I mean, if the regulatory committees really wanted to help, break up the monopolized geographic regions of broadband control.
     
  5. WXYZ

    WXYZ Well-Known Member

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    YES.......that NVDA merger will have a POTENTIAL hard time.....clearing antitrust issues. Here is what some are saying:

    "That's without even beginning to account for the antitrust implications of the deal. Because buying Arm would give NVIDIA over 90% of the smartphone chip market and a similar share of the embedded IoT silicon one. Courtesy of Arm's affordable licensing model that standardized its architectural designs in virtually every electronics niche bar traditional computers. Hauser also argues NVIDIA would inevitably dismantle Arm's business model on which so many of its direct rivals depend on."

    NVIDIA's Arm Acquisition 'An Absolute Disaster' – Co-Founder

    https://www.androidheadlines.com/2020/09/nvidia-arm-acquisition-disaster.html

    I.......MUST SAY.......I totally agree with his statement in the article as follows:

    "Selling the last globally relevant company on the Old Continent is an extremely short-sighted move, Hauser argued."

    I TOTALLY AGREE..........there are hardly any globally relevant companies in the EU or anywhere else in Europe. Of course........I am BIASED........since I have ABSOLUTELY ZERO interest in owning ANY non-American companies. OR.......perhaps it is NOT bias.......perhaps it is just common sense. Who knows?
     
    #2085 WXYZ, Sep 15, 2020
    Last edited: Sep 15, 2020
  6. WXYZ

    WXYZ Well-Known Member

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    NICE green day in my accounts today. Another step forward for the markets. The more distance we can put between ourselves and last week......the better.

    ALSO......a good beat of the SP500 by .68%.
     
  7. roadtonowhere08

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    Pretty sad that they would most likely not care. I mean I guess you could compare day trading to Vegas, but people with their head screwed on straight recognize the stock market as a way to increase assets and Vegas as... well... entertainment. Perhaps those that get a high off of trading will learn the hard way just like gambling addicts.

    The House always wins. I take this article as Robinhood not only screwing over their users but also users of other brokers like Vanguard who do not sell client data. I am sure there are similarities with the options and limit orders with both sets of users. This is not a new practice, like the article says, but this is probably ushering in a golden age of screwing over the retail investor.

    The only way to fight this is truly what XWYZ and many here have been saying all along: buy good companies and go long.
     
    #2087 roadtonowhere08, Sep 15, 2020
    Last edited: Sep 15, 2020
  8. zukodany

    zukodany Active Member

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    Well like it or hate it at least we see that NVDIA is making good plans and are looking for market domination. Will it go through with no regulations or backlash from other Arm licensing companies? That remains to be seen. Let’s see how Mr Huang business skills are. But dang, is he quick to jump into deals... This company shows a lot of promise and somehow this doesn’t look to me like a company that likes to bite more than they can chew
     
  9. roadtonowhere08

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    Oh no, I see NVIDIA as having a VERY bright(er) future. Jensen sees where the money and opportunity lies. He's going for it.
     
  10. WXYZ

    WXYZ Well-Known Member

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    I have owned NVDA a couple of times. BOTH TIMES.........one of the MAIN things I like about this company is the management and the fact that the primary founders are STILL very actively involved. They did not just cash out when they could. I LOVE companies that have long time active founders that are passionately involved in the business. This is a.........BIG factorto me in owning a..........little piece........of a company.
     
  11. WXYZ

    WXYZ Well-Known Member

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    The markets are.....NEVER.......safe if the Fed is talking. Perfect example today, they tanked the markets as usual. Well......not really the FED.........it is actually the MEDIA and the insanely sensitive investment "professionals" that ALWAYS read something negative into any comment from the FED. Just like the constant negativity that is ALWAYS apparent when it comes to any sort of company financial reports.

    SO........of course.......a RED day for me today and got beat by the SP500 by .68%. Onward and upward......tomorrow.
     
  12. A55

    A55 Active Member

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    Trevor Milton, Nikola
     
  13. B Russ

    B Russ Active Member

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    Ahhh i see what u did there! Haha. Context is key, obviously.
     
  14. A55

    A55 Active Member

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    Milton has been there since the beginning. Granted that there's a new CEO & CFO running the company. GOOD that more level headed business people are making decisions and overseeing the money. Milton is passionately involved. Although I suspect that the CEO won't allow the theatrics of fake, inoperable vehicles to be featured in the future. Some have suspected that they could pull Milton aside and reign in some of his chicanery.
     
  15. WXYZ

    WXYZ Well-Known Member

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    Sorry.........I tend to be in the negative camp..........at the moment.........on Nikola
     
  16. zukodany

    zukodany Active Member

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    Yup. You can make another ev. But you can’t make another Musk
     
  17. WXYZ

    WXYZ Well-Known Member

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    I have read the positive stuff and the negative stuff. I DO NOT like the responses of the company and the fact that......even if self imposed......they appear to be under SEC investigation. In addition.......I do not see anything about this company that shows that they have ANY sort of actual product. In my opinion.......it is all smoke and mirrors........and hope and prayers.

    I will ADMIT that I do not have deep knowledge of the company. BUT....with all the various allegations flying around......I would NOT touch this stock with a 100 foot pole. On the other hand.....if they do turn out to be a legit company with good product......will I buy the stock........NO. Either way I have absolutely ZERO interest in this company.
     
  18. WXYZ

    WXYZ Well-Known Member

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    Here is a "little" article on.........indirectly.......one of the two funds that I own.....Fidelity Contra fund. I dread the day that the long term manager chooses to leave this fund.....he has done an AMAZING job:

    Even Fidelity’s $230 Billion Star Danoff Has Robinhood Anxiety

    https://finance.yahoo.com/news/even-fidelity-230-billion-star-120000471.html

    (BOLD is my opinion OR what I consider important content)

    "Will Danoff has been wondering why billions of dollars keep flowing out of the Contrafund, the giant mutual fund he manages at Fidelity Investments. Performance isn’t the problem. He’s up 21% this year, trouncing the S&P 500’s 6.2% return. His conclusion: Today’s kids want something sexier.

    There’s a demographic issue,” Danoff, who has beaten the benchmark by an average of more than 3 percentage points annually over three decades, said in a Bloomberg Front Row interview. “We need to appeal to the Gen Z-ers and the younger generation as well, and luckily I think our app is quite good. But you know, a typical Gen Z-er may not be as interested in owning a mutual fund.”

    That assessment, from one of Fidelity’s biggest stars, captures the angst of an entire industry. For years, traditional mutual funds have been losing favor. Many investors were turned off by chronically poor performance, and others objected to paying commissions or annual fees that often approach 1%.

    There’s now less money in actively managed U.S. equity funds than in low-cost alternatives such as index funds and exchange-traded funds that track the market instead of trying to beat it. More recently, young investors have flocked to Robinhood Markets, making commission-free trades with a few taps on their smartphones.

    Next to the social media antics of celebrity speculator Dave Portnoy, Danoff’s world of buy-and-hold discipline seems antique by comparison.

    “When I started in 1990, there were 261 equity funds, and now there are thousands,” said Danoff, who manages $230 billion. “There are thousands of hedge funds. There are thousands or millions of Robinhood investors. There’s sovereign wealth funds, etc. So there’s no question that it’s become much, much more competitive.”

    Vast Resources

    Closely held Fidelity remains one of the titans of asset management, running some $3.3 trillion, and unlike most competitors the firm has embraced ETFs, runs a discount brokerage and even developed expertise in cryptocurrencies. Danoff said access to Fidelity’s vast resources is one of the reasons he’s been able to outperform the S&P 500 for so long.

    Yet he also recognizes the appeal of index products, whose growth in the 2010s eroded the economics of mutual funds and bookended the era when managers such as Peter Lynch, Bill Miller and Ken Heebner were household names. Last year, 71% of U.S. large-cap managers failed to beat the benchmark, according to S&P Global.

    One issue with investing in any actively managed fund is what happens when the fund manager retires or what happens if the fund manager loses his fastball,” said Danoff, 60. “And then, secondly, do I still trust my fund manager?”

    Managers also make mistakes. In Danoff’s case, he unloaded most of the Contrafund’s position in Tesla Inc. in 2017 and 2018, missing out on more than $10 billion of gains. Now, he’s stuck in limbo, confident that electric vehicles have a bright future, that Tesla is a great company and Elon Musk is a “remarkable executive.” But he’s apprehensive about buying into a capital-intensive business, not to mention the stock’s $411.6 billion valuation.

    Buffett’s Berkshire

    At the same time, Danoff has stuck with Berkshire Hathaway Inc., even though its returns have lagged behind the S&P 500 over the past decade.

    “The more I’ve spent time with Warren Buffett and, you know, attending annual meetings in Omaha, the more I like it,” he said. “With all my tech holdings, this is a very good counterbalance and some ballast for the big fund.”

    Size is something Danoff has to wrestle with, especially in the $139 billion Contrafund. As a manager who focuses on earnings growth, he built some of his top holdings in Amazon.com Inc., Facebook Inc., Apple Inc. and Alphabet Inc. -- companies so powerful they’ve become targets for antitrust regulators.

    “I do worry about that,” he said.

    For now, the Covid-19 pandemic has been a boon to Danoff’s portfolio, validating his long-term bets on software, social media, cloud computing and digital payments. The times also forced him to reckon with the role corporate America -- and the investors who back it -- plays in issues such as climate change, economic inequality and systemic racism.

    “Speaking up for civil rights or equal rights attracts a better-caliber employee,” Danoff said. “The great companies that I’m invested in care deeply about our country. They care deeply about the environment and they realize making all stakeholders happy is good for business and good for the shareholders.”

    MY COMMENT

    It is interesting that this fund and its manager that LIVES in the........"world of buy-and-hold discipline"...........has managed to BEAT the SP500..........."by an average of more than 3 percentage points annually over three decades".

    EXACTLY my kind of fund manager............the above information is EXACTLY why I own this fund.

    NOW.......when Danoff retires or is no longer fund manager........I will PROBABLY end up selling all shares. WHY.......because young managers and investment professionals..........in general......... have no appreciation or talent for long term investing. ANY new manager will want to put their own stamp on the fund and that will mean changes from what has made it successful.


     
  19. WXYZ

    WXYZ Well-Known Member

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    I am MUCH MORE tempted by Snowflake than any other new company right now. I MIGHT buy 100 shares at some point in the near future once the IPO MANIA eases up......as a long term speculative holding. I........like everyone.......have absolutely no idea if this company will pan out over the long term. BUT.........I need to do a lot more reading on their business model and product.

    The above is simply off the cuff. I definately need to research their business model WAY MORE since most of these sorts of........"better than sliced bread" companies.........FAIL to live up to all the hype.
     
    #2099 WXYZ, Sep 17, 2020
    Last edited: Sep 17, 2020
  20. WXYZ

    WXYZ Well-Known Member

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    HERE is a little info:

    Snowflake IPO: In-Depth Analysis

    https://www.forbes.com/sites/bethkindig/2020/09/11/snowflake-ipo-in-depth-analysis/#3417608f7986

    (BOLD is my opinion OR what I consider important content)

    Snowflake is the most anticipated IPO of the year. Investors should decide in advance how much they are willing to pay as Snowflake will test the upper limits of what it means to have a stretched valuation. Heck, the company has even inspired value-legend Warren Buffet to change his thesis and invest in an IPO prior to profitability (!)

    Perhaps because the company delivered sky-high revenue growth last fiscal year of 173% and 121% in the most recent quarter with a record-breaking net retention rate of 158% — which is the highest of any public cloud company at time of listing.

    [​IMG]
    David Marlin

    These industry-leading numbers are due to the company disrupting the data warehousing market with a superior cloud data platform that delivers across key differentiators (we review this below). Despite Snowflake demonstrating excellent product-market fit, clear competitive advantages, and strong management — no company is perfect. We go over a few key risks that investors should keep in mind as the bidding becomes fierce on opening day.

    Snowflake Financials
    Snowflake has strong financials for a tech IPO, yet it’s important to remember the product has been available for only six years and tech growth is typically strongest in the early days. The company delivered 173% growth in the fiscal year ending January 31, growing from $96.7 million to $264.7 million with gross profit margins of 56.2%.

    These gross margins are below what cloud companies are capable of yet improved in the most recent period. Revenue grew 133% year-over-year in the first six months of fiscal 2021 ending in July, growing from $104 million to $242 million with improving gross profit margins of 61.5%.

    In the most recent quarter, the company reported growth of 121%. Here, we already see the effects of age within a short time period as Snowflake settles from 173% growth to 133% growth and now to 121% growth. This is not a negative by any means (triple-digit growth is to be celebrated) but keep in perspective it’s age when comparing Snowflake to any high-growth cloud SaaS peers.

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    David Marlin

    The bottom line has been varied depending on what period you look at. The losses doubled from fiscal year 2019 with net losses of $178 million increasing to net losses of $348.5 million in fiscal year 2020.

    More recently in the first six months of fiscal 2021, the net losses were flat period-over-period at $177.2 million compared to losses of $171.3 million. This could be an encouraging sign or it could be Snowflake tightening the belt temporarily for the public offering before returning to the original pace of worsening losses. There is not enough history to know if the more encouraging flat rate of losses is sustainable. Adjusted EPS was negative $1.63 in the fiscal year ending in January compared to negative adjusted EPS of $0.72 in the first half of fiscal 2021.

    Net retention rate for Snowflake is a record 158% — the highest of any company when going public. However, it’s important to remember that net retention rate lowers over time as customers become harder to retain long-term (I cover net retention rates more in-depth here).

    The company was founded in 2012 yet the product came out of stealth mode in 2014. When considering the product launch, Snowflake is a very young company of only six years old.

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    David Marlin

    You can see evidence of how net retention is affected by number of years in Snowflake’s S-1 filing as the company had a rate of 223% in the first half of 2019 compared to 158% period-over-period. Annually, the company lost 11 percentage points in net retention rate from 180% to 169%.

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    Snowflake S-1 Filing

    Regardless, Snowflake has impressive numbers. Perhaps the most impressive key metric in the S-1 filing is the growth in the percentage of customers with product revenue greater than $1 million. This has grown considerably from 14% in fiscal year 2019 to 41% in fiscal year 2020. There is evidence high-end accounts are continuing to grow with the first six months of 2020 at 56% compared to 22% in the year-ago period.

    The new CEO, Frank Slootman, clearly knows how to make a company attractive to investors. Not only did the company quicky tighten its belt in regard to net losses, the company also doubled customers from 1,547 to 3,117 over the past twelve months. This includes 7 of the Fortune 10 and 146 of the Fortune 500.

    Cash used in operating activities decreased from $110 million to $45.3 million in the first six months of fiscal 2021. The company has cash and investments of $591 million and no debt.

    As outlined in the S-1, IDC places the addressable market for Analytics Data Management and Integration Platforms and Business Intelligence and Analytics Tools at $56 billion in 2020 and $84 billion in 2023.

    In an effort to narrow this addressable market, I dug up a few more sources. According to MarketsandMarkets, the addressable market for Data Warehouse-as-a-Service is much smaller at $1.2 billion in 2018 and set to grow to $3.4 billion by 2023 at a CAGR of 23.8%. P&S Intelligence reports a similar CAGR of 29.2%, estimating the Data Warehouse-as-a-Service market to reach $23.8 billion by 2030. When combining on-premise, Allied Market Research places the data warehousing market at $34.7 billion by 2025.

    You’ll find larger addressable markets in tech but the weight Snowflake brings to the category is considerable.

    Snowflake’s former CEO, Bob Muglia, grew the company from 80 customers in 2015 to 1000 customers in early 2018 when he was replaced by Frank Slootman. The change likely happened due to pressure from private investors who want a grand slam exit (and looks like they’ll be getting just that).

    Slootman is known for resuscitating Data Domain from nearly running out of money in 2003 to an acquisition in 2009 after the company “grew to sell more than all its competitors combined.” This was detailed in a book that Slootman wrote called: “TAPE SUCKS: Inside Data Domain, A Silicon Valley Growth Story.” Three years later, Slootman took over the CEO role of ServiceNow between 2011 to 2017 and grew the company from $75 million in annual revenue to $1.5 billion. This was achieved by diversifying the product beyond the IT department.

    For many investors, management is a key factor in deciding to invest or not. Here, Snowflake fires on yet another cylinder.

    Product:
    Snowflake’s decoupled architecture allows for compute and storage to scale separately with the storage provided from any cloud provider the customer chooses. By processing queries using massively parallel processing (MPP), where each node in the cluster stores a portion of the data set locally, the virtual warehouses can access the storage layer independently so as not to compete for compute power. With the competitors, such as Redshift, where compute and storage are coupled, more time is spent reconfiguring the cluster.

    Snowflake calls this offering a virtual data warehouse where workloads share the same data but can run independently. This is crucial because Snowflake’s competitors combine compute and storage and require customers to size and pay based on the largest workload.

    Data warehouses are centralized data repositories that collect and store information across many sources that are both internal and external. The raw data is ingested into the data warehouse and processed to answer queries. To ingest data, warehouses follow the ETL process, which is: (1) Extract the data from the internal or external database or file, (2) Transform by cleaning and preparing the data to fit the schema and constraints of the data warehouse and (3) Load into the data warehouse. The ETL method helps to organize the data into a relational format. Notably, Snowflake supports both ETL and ELT, which allows for data transformation during or after loading.

    One key product differentiator is that Snowflake is not built on Hadoop, rather the company uses a new SQL database engine with cloud-optimized architecture. Overall, this translates to faster queries and also reduces costs by scaling up or down for both capacity and performance. This also allows the shift to the cloud while still honoring traditional relational database tools. Just like cloud infrastructure does not require you to hold server space for peak times year-round, a cloud data warehouse does not require you to plan, acquire or manage resources for peak data demand (i.e. elasticity).

    The need for resources could change by either increasing or decreasing (scaling up or down). Customers that have a need for storage but less of a need for CPU computations do not have to pay up front and can shrink the environment dynamically. Users either pay for terabytes or are billed on a per-second basis for computations. Notably, Snowflake charges by execution-based usage and is not a cloud SaaS-company that charges by subscription.

    Snowflake has a multi-cluster architecture which is unique from single cluster databases. The multi-cluster approach allows the clusters to access the same underlying data yet to run independently. This allows for heavy queries and operations to run very quickly and with fewer errors because the queries are not accessing the same data warehouse.

    Queries are made with standard SQL, for analytics, and integrates with R and Python programming languages. The company delivers the ability to handle all incongruent data types in a single data warehouse. Because the data is accessible through SQL, there is widespread developer uptake as it’s the most common database language.

    Snowflake supports both structured data and semi-structured data. As machine-generated data grows to include applications, sensors and mobile devices, Snowflake allows semi-structure data to be handled without preparation or schema definitions. The result is handling JSON, Avro, ORC, Parquet or XML data as if it were relational and structured.

    Snowflake uses a compressed columnar database. Columnar databases are optimized for the fast retrieval of columns of data and is used for analytic data queries. Other features include centralized metadata management that is stored in a single-key value store that allows cloning of tables and databases. Security is baked into the platform to where Snowflake automatically encrypts all data to the point where unencrypted data is not even allowed. There is third-party certification and validation for security standards like HIPAA.

    Beyond the value proposition of separating storage from compute for speed, and also scaling up or down to reduce costs, the third takeaway is that Snowflake is also much easier for customers to use as it’s designed to remove the role of a database administrator for monitoring and/or to tune query performance.

    The end goal of choosing Snowflake is that you load data, run queries, and do little else – which is an immense value proposition due to the amount of time wasted prepping, balancing, tuning and monitoring traditional data warehouses originally built for on-premise.

    Snowflake is capitalizing on the multi-cloud trend and growing rapidly with customers who want a choice in public cloud provider despite the cloud giants having their own data warehouse systems, such as Amazon Redshift, Azure Synapse and Google Big Query.

    Generally speaking, Big Query is a closer competitor as Google’s offering also separates storage and compute. The differences between BigQuery and Snowflake include pricing structure where Snowflake is a time-based pricing model where users are charged for execution time and BigQuery is a query-based pricing model, where users are charged for the amount of data returned from the queries. BigQuery has a serverless feature that makes it easier to begin using the data warehouse a the serverless feature removes the need for manual scaling and performance tuning. Dremel is the query engine for BigQuery.

    When it comes to deciding between BigQuery and Snowflake, it can come down to what you do with the database due to pricing structure differences. For instance, Snowflake is a better choice for concurrent users and business intelligence. It’s also a great choice for data-as-a-service, where you might give client access to your data in the form of analytics. BigQuery is perhaps a better choice for ad hoc reporting, where you have occasional complex reports on a quarterly basis or recommendation models and machine learning that require high idle time. Again, these examples are mainly due to pricing structure.

    Despite BigQuery having a strong following with nearly twice the number of companies as Snowflake and growing around 40%, it tested slower than Snowflake in field tests performed by GigaOm in 2019. Vendor lock-in from BigQuery is also undesirable as companies may prefer AWS or Azure and/or more interoperability or best-in-breed solutions – we can see this in the growing trend of multi-cloud. AWS Redshift has the biggest market presence but growth is nearly flat at 6.5% and AWS is the leading partner for Snowflake.

    Here's a great write-up from the Hashmap Engineering and Technology Blog that points out why implementing optimized row columnar (ORC) format data loads is ideal for either Snowflake or Amazon Redshift due to the ORC file format. Again, ultimately the choice in which system you use comes down to the individual needs for implementation although Snowflake is designed to be a competitor in nearly every case.

    There’s a great write-up from analyst David Vellante that discusses how Snowflake competes with cloud native database giants. His analysis discusses survey responses from CIOs and IT buyers with Snowflake having a lead over the tech giants in spending intentions. The Enterprise Technology Research study he highlights showed 80% of AWS accounts plan to spend more on Snowflake in 2020 relative to 2019 with 35% adding Snowflake as new compared to 12% adding Redshift as new. In Azure, 78% plan to spend more on Snowflake with 41% adding new. On Google Cloud, 80% plan to increase spending on Snowflake. We can see the people have spoken.

    A few risks …
    Due to Snowflake’s product strengths, the public cloud providers offer Snowflake while at the same time being in competition. The main risk being discussed is that public cloud providers have competing databases, but in reality, the risk may be pricing pressure over time. Snowflake has a great top line; however, the bottom line is affected by its partnership with the competitors. Plus, tech giants can greatly undercut Snowflake on pricing. Therefore, margins may be an inherent issue.

    The company pays quite a bit for sales and marketing, which is typical for a company going public as this strengthens the top line yet could make it hard to balance this growth with profitability in the future. (But hey, if Berkshire doesn’t care, why should we!)

    In the S-1 filing, it was noted that Salesforce will buy $250 million in stock in a private placement. This could be a risk if Salesforce becomes too intertwined with Snowflake as it’s best possible growth will be achieved by stating neutral, in my opinion. This involvement is something to monitor.

    As stated, Berkshire Hathaway is also intending to purchase $250 million in shares in a private placement plus an additional $300 million from an unnamed stockholder in a secondary transaction. As Business Insider pointed out, this involvement from Berkshire is “rarer than a unicorn” and will be viewed as a strength by both institutions and retailers.

    There could be risk in Snowflake being cloud-native only and not offering hybrid or on-premise. This can limit the customer pool as enterprises prefer hybrid options. Perhaps the bigger picture for Snowflake’s strength will be leveraging artificial intelligence in applications and business intelligence, and in this case, a hybrid and on-premise offering won’t be as necessary.

    Valuation
    Snowflake’s amended filing on September 8th shows the company will be priced at $75 to $85 per share with a valuation between $20.9 billion and $23.7 billion. This would raise $2.7 billion. The last private valuation for Snowflake was $12.5 billion when the company raised a Series G for $479 million.

    When we look at various scenarios, we see Snowflake hitting 40 forward price-to-sales in the $30 billion valuation range.

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    Snowflake IPO Valuation Table

    Beth Kindig
    Snowflake is not profitable while Shopify, Zoom Video and Datadog are profitable with some showing accelerating revenue. These three have commanded above a 40 forward price-to-sales in perfect conditions only. The majority of their trading history has been beneath a 30 forward price-to-sales. Being profitable should come with a premium yet Snowflake will likely inch its way into this valuation range without demonstrating profitability.

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    Snowflake's IPO opening price will test the upper limits of high growth valuations.

    Beth Kindig
    When we look at Zoom Video, Crowdstrike and Datadog, we see these three traded at or beneath their opening IPO price many times in the year following IPO. Crowdstrike saw roughly a 50% drawdown from its opening price.

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    Snowflake's IPO opening price may not sustain if history is any indication

    Beth Kindig
    Therefore, if Snowflake trades at a 30 forward price-to-sales and sustains this valuation, it will be the first high growth company with negative earnings to do so. Even those with positive earnings growth have only traded above this valuation for a brief period over the last three months.

    A better strategy would be not pay over this amount and count on history rhyming. At NTM revenue of $750 million, that means Snowflake would have to open at the price listed in the prospectus in order to remain within a reasonable $25 billion valuation (“reasonable” being used loosely here as only a few companies have traded at this valuation in the most ideal conditions/tech market and these comparables were profitable).

    Conclusion:
    When you were a child, your parents probably asked, “are you going to jump off a bridge if everyone else does?” The goal of the question was to get you to think for yourself in the face of peer pressure.

    In this situation, the question that should be asked is, “are you going to invest in a company with triple-digit growth, clear product differentiation, key metrics that prove product-market fit and gravity-defying management … if Berkshire does?” The answer is probably “yes.”

    The issue is that we aren’t Berkshire or Salesforce so we will probably overpay. Therefore, the biggest risk of all is how much alpha will be left in the first year of trading by the time retailers are offered the crumbs.

    I’ve participated in IPOs out the gate and the only ones that have paid off were under-hyped (Roku). Those that were over-hyped, such as Zoom Video and Crowdstrike, either retreated back to their opening price or saw up to a 50% haircut from the opening price.

    I did not participate in either of these over-hyped IPOs but I did snag Zoom Video later in January of 2020. I was able to put that money to use elsewhere while waiting for the lock-up period to expire and the right entry in the low $60s nearly 9 months after Zoom Video had listed.

    Even as a Snowflake enthusiast. I may back-off after 30 forward price-to-sales (and most certainly at 40 forward P/S) as I’m confident I can find many great tech companies that are less hyped while I wait it out. We will always see periods of indiscriminate selling across high-growth and I don’t think Snowflake will escape those rotations."
     
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