I’ve seen a number of articles recently, at least two referencing industry authority Morningstar, pointing out the weak performance of the ARK group of ETFs over recent years. The ARK flagship, AARK, the ARK Innovation ETF, is up in total by about 10% over the past five years, a span which includes the pandemic (when ARKK was a moonshot) and the subsequent economic recovery.

Compared with major stock indices, the five-year record is as follows:

NASDAQ +110%

S&P 500 +81%

ARKK +10%.

ARKK has fallen by about 2/3 in price since its top in early 2021. Unfortunately–but not unusually for products directed at retail investors–a very large chunk of the share total is money that came in at the very top. The result of this is that, as I look at the situation, the largest single asset of ARKK is the tax value of the accumulated losses incurred since then.

In a more conventional situation, a new portfolio manager would be named, ideally someone with turnaround experience and most likely from outside the organization.

As it turns out, I’ve been the “new guy” twice in my investing career. Although it’s risky to generalize from two instances:

–it’s important to use the tax losses as soon as possible. This is also a luxury, because it allows the manager to trade aggressively without having to worry about distributing taxable short-term profits to shareholders. This is much less important than fixing the overall portfolio but it’s still a potential extra source of return

–my experience has been that shareholders who have losses tend only to sell when they are back to breakeven. This makes no economic sense, in my view, but it’s what happens. This isn’t all bad, both because it’s part of the healing process and because strong performance will ultimately attract new shareholders.

I have no idea what will happen in the ARK case, but it will be interesting to see.

an unrelated reminiscence

On the trading point and taxes, I was running (another turnaround) a successful small-cap global fund years ago, when I was asked to relinquish it to a “stellar-performing” small-cap specialist from the firm’s pension arena, as part of the asset management company’s restructuring. My largest holding at the time was Qualcomm, a stock that went up 10x over the following two years. The new manager sold it immediately, commenting that my former portfolio was riddled with “trash” like this. His efforts resulted not only in steep underperformance but also a taxable distribution equal to a third of the fund NAV. The fund ended up being closed. The inept manager left the firm as he was about to be fired: an outside consultant discovered that the performance reports he’d created over the years, portraying him as an outperformer, actually disguised the fact he was perennially in the bottom decile. The CIO he’d reported to was booted at the same time for having been deceived for so long. What I find particularly amusing is that this manager is still working in the industry and even appears as an expert on CNBC from time to time.

It’s more “it can’t hurt” than anything significant.

A generation ago, when brokers charged up to an 8% commission for purchases of mutual funds, they also charged a larger commission for “odd” lots (this depended on the stock, but was usually anything less than 100 shares) than a “round” lot (usually 100 shares).

Companies felt they got greater support from individual investors if their stock was at a price where most people could afford to buy a round lot. So companies whose strong earnings growth had driven the share price above that level would split, with 4-for-3, 3-for-2, 2-for-1 and 3-for-1 being among the most popular.

In today’s world, where wider bid-asked spreads have taken the place of commissions at discount brokers, a split may have some old-school appeal but is otherwise irrelevant, in my opinion.

In other markets, a split–or a stock dividend, which is basically the same thing in a different wrapper–may contain a signal of expected strong future earnings growth. But I don’t think this has ever been the case in the US market.

Finance academics back in the day did research establishing that stocks that split had sub-par performance in the months after the split became effective. This shows, they argued, that splits mean nothing. This completely missed the point. The academics overlooked (what a surprise) that stocks that split–like WMT did often in its glory days–outperformed during the months between the split being announced and its becoming effective. Some, WMT in particular, also tended to outperform in anticipation of a coming split announcement.

The Dow Jones name has wide recognition, particularly for the man in the street who has no particular interest in the stock market. To my mind, by far the most important aspect of the Dow Jones indices in today’s world people who use them to talk about stocks identify themselves at the outset as totally clueless.

The DJI debuted in 1896, as the first index of stock market activity in the US. Its defining quirk is that the weighting of a given stock in the index depends on its per share price, not on its total market capitalization (which is the way more modern indices are constructed). So a company with ten shares selling at $1000 each (= a $10,000 market cap) would have a higher weight than, say, Walmart, which has a market cap of close to half a trillion dollars but whose shares sell for about $175 each.

The plus of the Dow methodology is that the index is easy to calculate by hand. I can see that back when the light bulb was a radical new technology this would have been an important selling point.

When I entered the stock market in 1978, mostly because I needed a job, the DJI still had some significance. It was filled with large, very mature companies. But you knew that when the Dow started to outperform the S&P it meant that the upward move was close to being over. The biggest, stodgiest companies were moving, so this meant there was nothing else left to buy.

In 2011, S&P acquired the Dow indices and began an overhaul aimed, as I see it, at making them relevant once again to people with an interest in stocks. My sense is that this worked for a while. But over the past year, the S&P 500 is +27%, and NASDAQ +39%. The DJI has trailed badly, at +18%.

I think this divergence is the reason for the switch from WBA to AMZN.

Overnight, NVDA reported 4Q and full year results. What struck me:

–revenue was up by 22%, quarter on quarter, despite a falloff in business with China due to US government restrictions on sales of advanced chips there. Revenue was up by 265% yoy.

–the gross margin was 76%, up 12.7 points yoy ,,,but up by 2.0 points q on q. I interpret this as saying that unit selling prices have been rising much, much faster than production costs but that this source of operating leverage is beginning to disappear. Usually not a good thing. On the other hand, the company says it has hit a “tipping point” where demand growth is accelerating, suggesting that this will be able to offset part or all of the diminishing operating leverage

–on the other hand, operating expenses were $3.2 billion for the quarter, flattish q on q and up by 23% yoy. Again a source of positive operating leverage, though a less powerful one than the gross margin.

The result of all this is that sales were up in Q4 by 265% yoy. Earnings grew by 765%, triple the size of sales growth, because of the two sources of operating leverage just described.

If we annualize 4Q eps, the stock is now trading at about 38x forward earnings. If we think revenue is going to double in the coming year–implying eps will do something modestly more than that–then the stock is trading at maybe 18x. In the latter case, the stock is cheap. In the former, it’s less of a slam dunk. For the first time in a long while, however, these questions are important ones to have answers for.

Concept is the story behind a stock. It can be a simple as the elevator pitch that explains why a given stock is potentially interesting. For example: Nvidia (NVDA) is the king of AI chips and AI is the future of just about everything. One might add that the company is growing at 50%+ per year but only trading at 35x this year’s expected eps. Usually, though, it’s a business line by business line analysis of possibilities over the coming, say, five years.

Valuation is the argument that a stock is cheap. Valuation can sometimes, paradoxically, be the concept, too–especially so for the deepest value investors. But it’s handy to separate the two. Cheap often means trading at a discount to a key balance sheet metric, like shareholders equity (book value) or net working capital or net cash (the letter two being Depression-era benchmarks that Graham and Dodd used; Japan is the only place you might see this nowadays, and that’s most likely an indicator that the company is family-controlled and not able to be acquired).

In an up market, Concept dominates. In a serious down market, Valuation is all people worry about. Think the second half of 2020 for the first, 2007-08 for the second.

My sense, from reading market commentaries, that pundits overall think we’re in a concept-driven market. I think that’s true only in the very narrow sense that the air continues to come out of pandemic darlings that, even now, have been driven more by hope than underpinned by earnings. I regard this as more or less looking in the rear-view mirror.

In addition, if we look at ARKK, arguably the ultimate in concept investing, it’s down by -9.7% ytd, as I’m writing this, vs. +4.1% for the S&P 500 and +1.6% for the NASDAQ. On a one-year view, ARKK is well ahead of NASDAQ but trails the S&P. The point here is that after their big runup in 4Q23, the market had already begun to move away from the riskiest stocks almost two months ago. (For what it’s worth, my sense is that what’s happening now is the final pandemic-stock housecleaning. Again, using ARKK as a barometer, that ETF is off by about 2/3 since its top three years ago. This compares with +50% for the S&P since then and about +10% for the NASDAQ (which peaked in late 2021. From the latter high, NASDAQ is basically flat. Who knows what will happen, but it’s hard to imagine further punishment from more or less the same group of stocks.)

NVDA, again

It will be interesting to see what happens when NVDA reports after the close today. It’s off its ytd high by about 8% in the past few days, after almost tripling out of the gate in 2024. If I’m correct that Wall Street has substituted fast-reacting bots for human, spreadsheet-creating industry experts trying to predict–and act in advance of–earnings, then there should be strong action in either direction, depending on the earnings news. My hunch is that this will be more true if the earnings are disappointing than if they’re surprisingly good. That’s mostly because it’s (untrained) human nature to not want to admit a mistake–so that takes everyone who’s sold in the last week out of the game, I think. But I have no real idea. It will be interesting to watch.

Myself, I’ve held NVDA, thanks to my son Brendan, for years. I have no intention to sell. And I have enough that I haven’t even set a target at which I’d be a buyer. That last sentence would be very bearish if there were lots of holders like me–because it suggests buyers on bad news might be thin on the ground.