I: 2023 Investment Review: Focus on Method Optimization and Expanded Research Coverage
In 2023, the most crucial aspect was optimizing our investment methods, which indeed proved effective:
1. Incorporating macroeconomic factors into our pricing framework, we utilized a pricing method applicable across various markets, industries, and companies. Benefits:
a) This approach allowed for a rough quantitative evaluation across different stock markets, estimating a reasonable overall market pricing under various macroeconomic scenarios. By calculating potential returns using a more fundamental value-investing approach, we avoided losses that might have resulted from hastily entering the seemingly undervalued Hong Kong market, as well as missed opportunities in the apparently overvalued U.S. stock market.
b) We considered investment returns from a comprehensive perspective, not just current performance and valuation but also growth in performance, changes in valuation, and returns from dividends and buybacks. By taking into account business models, life cycles, and competitiveness, we applied different valuation discounts/premiums. This reflects the varying levels of predictability in different types and qualities of companies. Even if companies have similar recent performance growth, different target valuations are assigned based on the aforementioned factors. Our improved pricing method enabled us to seize investment opportunities in companies like MSFT and MA, which may not appear fast-growing but offer substantial investment returns.
2. Incorporating "going with the flow" in our investment decisions. After selecting our targets, we considered how much to invest based on a "going with the flow" approach. We allocated relatively higher proportions to companies where the investment logic was validated, the fundamentals could potentially outperform expectations, or the trend in fundamentals was positive for the foreseeable future. Conversely, we invested less in companies with decent investment returns but recent negative fundamentals or unvalidated investment logic. We actively tracked and timely adjusted these factors.
3. Adopting a probabilistic perspective on future opportunities.We embraced the likelihood of future outcomes being a range of probabilities rather than a single definite point. This approach helped us maintain an open mindset, avoiding biases and accepting that the future is a range of probabilities that may dynamically adjust over time. In practice, upon identifying an opportunity, we quantified optimistic, pessimistic, and most likely scenarios, dynamically adjusting based on tracking. If a neutral scenario began leaning towards the pessimistic, we might not immediately clear our position but would start by making minor adjustments in our holdings.
4. Enhancing our tracking system.We improved our tracking system for covered industries and companies, tracking industry data, company data, and peer data weekly. We also included core sell-side expectations and market trends in our tracking system, investigating the reasons behind significant divergences. This tracking helped us identify issues and promptly revise investment decisions.
Secondly, there was a significant increase in our team's research coverage.
This year, we expanded our coverage to include more industries and companies, allowing for diversification in investment logic, industry, and market perspectives. This approach helps mitigate the impact of erroneous judgments on the overall portfolio's returns.
Currently, our core coverage includes approximately 50 companies, encompassing sectors such as cloud computing, semiconductors, internet, payments, smart vehicles, retail, luxury goods, overseas catering, new beverages, and sports equipment, primarily focusing on technology and consumer domains. Additionally, we cover over 200 other companies, albeit with relatively less depth and tracking intensity.
II: 2024 Investment Outlook
1. On the macro level, we are relatively cautious domestically and more optimistic internationally, but we will maintain an open mindset and revise our views according to actual developments. Domestically, we currently don't see a main driver that could quickly leverage and turn the situation around. With slowing growth, many industries face intensified competition. Adjustments in supply will take time, and profit performance may be worse than revenue. Additionally, changes in industrial and regulatory policies could alter market pricing logic, leading to a lack of long-term visibility and making asset pricing challenging. Thus, we are generally cautious. However, on a micro level, we are very optimistic and active. The key is that the Chinese people and enterprises generally refuse to settle. Those industries and companies that withstand domestic competition have strong comparative advantages internationally. Any company that can stand firm in the domestic market and is not rejected in other markets has an opportunity.
Internationally, we are relatively more optimistic. The current long-term interest rate of around 4% is still high relative to the medium to long-term nominal economic growth rate (especially after a rapid decline in inflation). Once inflation falls, the Federal Reserve has no burden to maintain high rates. If employment or the economy worsens unexpectedly, the Fed could act quickly to start lowering rates, and it's not impossible that rate cuts could precede a change in fundamentals.
2. Market valuations are reasonably set; the "expensive" is justifiably so, and the "cheap" has its reasons. Current valuations in China (A-shares, H-shares, Chinese concept stocks) and the US market largely reflect the current risk-free rate of return, risk perception, and medium to long-term economic expectations. The pricing is reasonable (unless there is a significant adjustment in macroeconomic judgment). Corresponding reasonable valuations for the US are slightly over 20x, about 15x for A-shares, and around 10x for Hong Kong stocks and Chinese concept stocks.
If an optimistic scenario unfolds (e.g., risk-free rates of return and risk premiums lower than expected), the US market's reasonable valuation could rise close to 30x. Conversely, in a pessimistic scenario, it could fall to 18x. However, in any case, the companies we heavily cover are expected to provide positive returns.
Macro judgments are prone to errors, and we don't believe all these judgments are correct. Once there's a change, we will adjust quickly.
Where are the Opportunities?
AI as a Source of Mid-to-Long Term Alpha. The value of human efficiency is increasingly recognized, making tools/services that enhance or even replace human efforts more valuable. AI has immense potential in this area (with no visible limit as of now) and is just beginning. While short-term expectations might be a bit high, it's more likely that the long-term prospects are underestimated rather than overestimated. In fields with a clear competitive landscape and where the winners are evident, whether they exceed or fall short of short-term expectations isn't very crucial. This is because the bulk of a company's value from a pricing perspective is in the mid-to-long term. The recent 3-5 years of earnings/cash flow don't have a significant impact. What's more important is the long-term foresight. We are relatively optimistic about the application of AI in enterprise services, while the 2C services are still unclear about “who” will emerge as leaders, which we are observing. Regarding AI hardware, in the long term, training is just a small part of the demand. The bigger part is inference, and the landscape there is not as clear, so the pace of AI advancement in the short term can cause more significant disturbances in long-term judgments. Lastly, Edge AI is an area we are very interested in. Whether major models will mainly run in the cloud or at the edge, or a combination of both, is still undecided. But if Edge AI gains a foothold, it could have a positive impact on terminal hardware.
Finding Consumer Opportunities Around Lifestyle Changes.People are increasingly pursuing healthier lives, focusing more on personal needs and experiences rather than pleasing others. This trend, which has been happening for a long time and is far from over, especially after the pandemic, has made people value health, life, and relationships more. These lifestyle changes bring structural opportunities to various fields like restaurants, beverages, clothing, and tourism. For instance, in terms of eating, there's a need for healthier and tastier options. In beverages, Americans used to drink one bottled beverage a day, with carbonated drinks every four days and energy drinks (especially sugar-free ones) even less frequently. As energy drinks become fresher in taste and sugar-free, and offer better value than freshly ground coffee, their consumption ratio is expected to continue increasing. In terms of clothing, as workplace dress codes relax and the demand for sports increases, people may prefer to unify what they wear for work and sports, benefiting brands that can combine both.
Investment Opportunities in the Aftermath of Inflation.Despite the decline in U.S. inflation, its aftereffects persist, including a significant increase in the value of labor (with per capita GDP rising to $80,000), and a steep rise in rent prices that are hard to reduce. This leads to the following changes and opportunities: a) In fields where rent and labor are significant costs, new entrants might be disadvantaged, benefiting existing players and affecting the competitive landscape, including in dining, tourism, hotels, etc. b) Services that assist or replace human efforts, like AI and software technology, become more valuable. c) Areas offering cheaper products/services, such as overseas e-commerce.
Reassessing Opportunities after Interest Rate Declines.Finally, if we enter a rate-cutting cycle, some sectors with good competitive layouts and long-term potential, which were previously hard to assess due to continuous interest rate hikes, might also become opportunities once short-term interest rate risks are resolved.
Wishing you a successful investment journey in 2024！
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