Investor Essentials Daily

Just like with GameStop, Steve Cohen is known for betting with and against his employees…does he have the right angle this time?

April 1, 2022

In the midst of the meme stock short squeeze last year, Point72 and Citadel provided liquidity to help Melvin Capital get through their liquidity crunch. However, their motivations may not have been completely altruistic.

Steve Cohen, the head of Point72, might be a great stock trader, but his real skill is knowing when to trade with and against his employees.

As he requests his liquidity back, it is fair to wonder if the GameStop bet has run its course. Read on to see if he thinks that he’s got the right idea with the rest of the portfolio as his bet in GameStop begins to close out.

Also below, a detailed Uniform Accounting tearsheet of the fund’s largest holdings.

Investor Essentials Daily:
Friday Uniform Portfolio Analytics
Powered by Valens Research

The meme stock craze that started in 2021 was kicked off by a short squeeze on GameStop (GME). It was a David and Goliath story between retail investors united on social media against massive hedge funds.

In the midst of it all, two market titans, Citadel and Point72, chose to put money in to backstop the hedge fund at the heart of the short squeeze, Melvin Capital.

Even though it was sold to the public as a lifeline to Melvin Capital, it wasn’t a purely altruistic move.

It was cold hard calculus from established market titans.

They understood if they didn’t backstop Melvin Capital, it could trigger potential liquidity issues in other securities. Also, Steve Cohen, the head of Point72, formerly SAC Capital, had an inside track into the firm.

His reputation with the word “inside” is for having gotten a slap on the wrist for insider trading accusations before, but that’s not what we’re referring to this time. Rather, he had an inside track because he knew the head of Melvin Capital, Gabe Plotkin.

Plotkin previously worked at SAC before he started his own fund, Melvin Capital. However, there are many traders at SAC, so it’s not very impressive in its own right.

The connection is important to note because many in the industry say that what Steve Cohen is really good at isn’t being a stock market trader. It’s being a trader with, and against, his own team.

He is known for having a keen eye to understand when his employees may make a wrong call and when to back away, and when employees are locked in and have a winning idea.

With that in mind, the fact that he backed Plotkin last year during the craze might have been a sign that he had an inkling that from such a poor trade position, Plotkin could be in a good position to dig his way out.

However, now that he’s unwinding his trade in Melvin, requesting the liquidity he provided the firm, it may be a signal that he thinks the trade may have run its course.

While the Melvin Capital “trade” is a prime example of his ability to manage his employees and their books, it’s not the only one of its kind. You can get an even better window of that by looking at Point72’s book itself, and see how well he’s managing his own and his employees’ book there.

Let’s see if Uniform Accounting thinks that he’s got the right angle on the stocks in his fund.

Economic productivity is massively misunderstood on Wall Street. This is reflected by the 130+ distortions in the Generally Accepted Accounting Principles (GAAP) that make as-reported results poor representations of real economic productivity.

These distortions include the poor capitalization of R&D, the use of goodwill and intangibles to inflate a company’s asset base, a poor understanding of one-off expense line items, as well as flawed acquisition accounting.

It is no surprise that once many of these distortions are accounted for, it becomes apparent which companies are in reality robustly profitable and which may not be as strong of an investment.

Contrary to what one might expect with the market correction in the past few months, most of Point72’s largest holdings remain in a better position than you would expect.

The average as-reported ROA among Point72’s top 15 names is near the cost of capital at 7%. In reality, though, these companies perform more like a largely profitable company, with a 37% Uniform ROA.

One of the fund’s largest investments, Booking Holdings (BKNG), for example, doesn’t return a below average 7%. It actually provides drastically stronger returns, at a 214% Uniform ROA which takes into account their strong recovery in travel from the pandemic.

Some of Point72’s other investments are also much stronger than they appear. For example, The Coca-Cola Company (KO) does not have 7% returns. Rather, as a company with a strong portfolio of products, it has a 43% Uniform ROA.

Furthermore, Jazz Pharmaceuticals (JAZZ) doesn’t have returns below cost of capital of 4%. Rather, they have strong returns of 41%.

Largely, once we account for Uniform Accounting adjustments, we can see that many of these companies are strong stocks that are priced to grow at strong rates or are fairly priced.

These dislocations demonstrate that most of these firms are in a different financial position than GAAP may make their books appear. But there is another crucial step in the search for alpha. Investors need to also find companies that are performing better than their valuations imply.

Valens has built a systematic process called Embedded Expectations Analysis to help investors get a sense of the future performance already baked into a company’s current stock price. Take a look:

This chart shows four interesting data points:

  • The Uniform ROA FY0 represents the company’s current return on assets, which is a crucial benchmark for contextualizing expectations.
  • The analyst-expected Uniform ROA represents what ROA is forecasted to do over the next two years. To get the ROA value, we take consensus Wall Street estimates and we convert them to the Uniform Accounting framework.
  • The market-implied Uniform ROA is what the market thinks Uniform ROA is going to be in the three years following the analyst expectations, which for most companies here is 2023, 2024, and 2025. Here, we show the sort of economic productivity a company needs to achieve to justify its current stock price.
  • The Uniform P/E is our measure of how expensive a company is relative to its Uniform earnings. For reference, average Uniform P/E across the investing universe is roughly 24x.

Embedded Expectations Analysis of Point72 paints a clear picture of the fund. The stocks it tracks are high growth names, but the market is failing to price in just how much they will grow.

While the market is pricing these companies to grow their economic profitability to 64%, analyst expectations have them climbing to 93%.

After a couple of challenging years due to pandemic-related headwinds, Bookings Holdings is poised to take flight with an ROA of 819% and market expectations of nearly half that at 427%.

While not as dramatic as an upswing, Micron (MU) is also poised to provide upside for the Point72 portfolio just as Bookings Holdings is expected to do. With the market implying ROA to fall to 0%, analyst expectations of 17% ROA could be another way for the portfolio to rise.

This just goes to show the importance of valuation in the investing process. Finding a company with strong growth is only half of the process. The other, just as important part, is understanding just how much more upside the company has left in them.

To see a list of companies that have great performance and future upside also at attractive valuations, the Valens Conviction Long Idea List is the place to look. The conviction list is powered by the Valens database, which offers access to full Uniform Accounting metrics for thousands of companies.

Click here to get access.

Read on to see a detailed tearsheet of the largest holding in AMZN.

SUMMARY and, Inc. Tearsheet

As Point72’s largest individual stock holdings, we’re highlighting, Inc.’s (AMZN:USA) tearsheet today.

As the Uniform Accounting tearsheet for, Inc. highlights, its Uniform P/E trades at 45.3x, which is above the global corporate average of 24.0x, but around its historical average of 44.0x.

High P/Es require high EPS growth to sustain them. In the case of Amazon, the company has recently shown a Uniform EPS growth of 47%.

Wall Street analysts provide stock and valuation recommendations that, in general, provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Amazon’s Wall Street analyst-driven forecast is for EPS to grow by 7% and 29% in 2022 and 2023, respectively.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Amazon’s $3,225 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to grow by 22% annually over the next three years. What Wall Street analysts expect for Amazon’s earnings growth is below what the current stock market valuation requires in 2022, but above that requirement in 2023.

Meanwhile, the company’s earning power is 2x the long-run corporate averages. Also, cash flows and cash on hand are 2x total obligations—including debt maturities and capex maintenance. Moreover, intrinsic credit risk is 40 bps. Together, these signal low operating and credit risks.

Lastly, Amazon’s Uniform earnings growth is above its peer averages and is trading above its average peer valuations.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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