We are removing Google from our Top5 Picks for 2022 and recommend investors stay in cash. As a result of their greater market share of the total ad market today, we believe estimates for advertising based internet companies like Google & Facebook are more at risk than is commonly believed.
In 2021, Google reached $258B in revenues (29% of ad industry rev) while Facebook was $118B (13% of total ad industry rev) with digital ad spending in total have grown from 12% share to 2/3rds share of the total $900B ad market over the past 12 years.
During the Great Recession of 2008-2009, Google revenue was only $24B or 3% of ad industry rev while Facebook at $777M was 0.5% in 2009. Both companies were able to grow during that downturn as the internet was gaining momentum as an advertising medium with only ~12% of ad spending online.
But both traditional and digital ad spending is likely to get hit over the next 18 months during a recession. During the 2008-09 Great Recession, US ad spending declined by 6% in 2008 and by 18% in 2009. This decline for two consecutive years last occurred in 1940. Digital ad spending, however, was up slightly in 2008 and down only mid-single digits in 2009. I believe history has skewed peoples view of the resiliency of the online ad market. Google in fact saw revenues increase by 31% in 2008 and by 9% in 2009 as the internet economy gained share. The much smaller Facebook saw revenues grow 78% in 2008 and 186% in 2009.
The launch of the iPhone in January of 2007 also helped shift viewing habits online as you could essentially surf the internet from anywhere versus from just your PC. This drove even more ad dollars online despite a recession.
We thought Google should have been able to outperform the overall market even during a down 30-50% decline in the S&P during a recession given their prodigious cash generation, reasonable market valuation and focus on future innovations. However we believe the dollars available to all online ad companies going forward including Google will also be less than we originally thought due to share gains over the near-term at:
1) TikTok (~$4B in revs in 2021 and projected to do $12B in 2022),
2) Amazon ($31B in ad revs in 2021 & up 33% in Q4 as it ramps its focus on their ad business)
3) Apple (~$4B in ad revs and up over 3x in 2021 driven by privacy changes)
4) Netflix (coming before year-end which could be a big drain in ad dollars given they have over 20% of US streaming audience share).
Netflix on the margin tipped it for us with our Google recommendation as some people will switch to a cheaper ad supported tier during a recession. Netflix has 222M global subscribers currently. That is a fair bit of ad inventory that could potentially be added to the market. We have already seen the damage TikTok has caused at Facebook.
Finally, with the world slowly opening up, people are spending time away from their screens as they go engage in leisure & travel activities. This will cut the amount of time consumers are on the internet and reduce monetization opportunities for Google.
In summary, as a result of our belief in 1) an impending recession, 2) online advertising share gains at TikTok, Amazon, and new entrant Netflix, and 3) less time spent by consumers online as they engage in travel & leisure activities, the ad sector (both traditional and online) is an area where we have short positions currently. We think street consensus of 34% revenue growth at Google and 22% at Facebook over the next two years is optimistic to say the least.
At some point in 2023 when the market hits its ultimate bottom, Google will be one of the first names we buy for the long-term given their culture of innovation, solid cash generation and reasonable multiple compared to their long-term growth potential.
Recap of our top 5 Stock picks for 2021
Our top 5 picks for 2021 are up a solid 25% on average through 12/28/21 following a powerful 60% return in 2020 for our Top 5 picks. While our top 5 picks for 2020 were technology focused ($AMD $DIS $FB $LITE $NVDA), our top 5 picks for 2021 had a value reopening bias and were $XLE $JPM $ORCL $MGA $BETZ (replaced $GAN on 1/19/21)
$XLE (up 48% YTD) benefitted from oil prices that rose over 50% in 2021 as investors gained more confidence in the world surviving the global pandemic and slowly reopening. We see Covid by late 2022 being more transmissible but less lethal with each mutation as is common with most viruses. Furthermore, we will have the development of more vaccines, including oral pills, and home testing capabilities. A year from now, we see Covid being viewed much like the flu which still kills 30-40K people each year in the US but is an acceptable risk of living life. When global mobility returns and manufacturing bottlenecks ease, crude consumption of roughly 96M barrels per day in 2021 could rise in 2022 to surpass the pre pandemic record of 99.6M in 2019. At the same time, supply will be restricted by environmental considerations. This should pressure oil prices higher in 2022. We continue to like this sector but with a different investment as you will see in our Top 5 Picks for 2022.
$JPM (up 25% YTD) benefitted from 10-year treasury yields that rose from 92 bps to 148 bps as investors gained more confidence in the world surviving the global pandemic and slowly reopening. As easy monetary and fiscal policies get dialed back in 2022, corporations and individuals will increasingly have to turn to the banking system for their financing needs going forward. In addition, as rates head higher in 2022, this will allow banks to lend at higher levels and increase their profitability. Valuations at a discount to the S&P combined with solid dividend yields should enable the sector to be also more defensive during market turbulence. We still like exposure to the banking sector for 2022. We continue to like the financial sector but with a different investment as you will see in our Top 5 Picks for 2022.
$ORCL (up 37% YTD) saw investors rerate their valuation multiple higher based on improving prospects for their cloud business as we predicted. Their pending acquisition of $CERN has disrupted the upward momentum in their stock driven by their cloud business. However, we believe at some point the stock will bottom and have a solid 2022 given the longer-term merits of the acquisition on their earnings, cloud revenues and healthcare business.
$MGA (up 13% YTD) surged to start the year (up 47% by 6/4/21) as a cheap play on Electric Vehicles but gave back most of those gains as semiconductor shortages affected production. We still like exposure to the EV theme over the longer-term but are exposed to it through a long position on $GM (0.6x 2022 EV/Sales) hedged with shorts on the more speculative EV car manufacturers (OEMs) (~25-30x 2022 EV/Sales.) These shorts we trade frequently given their high volatility and retail investor driven moves. Overall, we believe that EV industry revenues will continue to grow at over 25% per year for the next 5+ years as countries and OEMs try to reach their EV goals. We prefer a value-oriented approach to investing in the EV space in 2022 as Central banks raise rates which is likely to compress multiples in the market for long duration, unprofitable names with high valuations. In addition, even industry leader Tesla had to struggle with issues when they ramped manufacturing. Supply chains today are still challenging with the traditional car manufacturers all trying to ramp their EV vehicles as well. This is likely to create manufacturing issues for the newer pure EV public companies.
$BETZ (down 5% YTD.) We replaced $GAN, up 16% from 12/31/21-1/19/21, with $BETZ, up 11% from 12/31/21-1/19/21 (see danniles.com/articles/01-19-2021) as a top pick given our concerns around $GAN or any individual investment in the space. The combined return was flat YTD ($GAN up 16.4% from 12/31/21-1/19/21 minus $BETZ which lost 14.4% from 1/19/21-12/28/21). In hindsight, we should have been more concerned. $BETZ was our worst pick and went from being up 27% on 3/15 to down 5% YTD. This was due to a combination of: 1) a high tax rate in New York on online sports betting; 2) intense price competition for customers; 3) greater variability on sports book profits; 4) pushed out profitability on greater investments; and 5) China regulatory and Covid related issues in Macau. In particular, the increasing focus on profits by investors in 2021 offset the positives of ongoing strong revenue growth of the industry. For example, sports betting bell weather $DKNG should see revenues roughly double this year while the stock is down 39% YTD. We also think tax loss selling and window dressing by portfolio managers has also punished the space into year-end. However, we still see many tailwinds for the sports betting space despite stock price performance this year. State legalization of sports betting is at nearly 30 states today with roughly 20 allowing online betting. Continuing legalization and more in game sports betting will be a tailwind for the next several years. Much like the surge seen in e-commerce names following the shakeout during the tech bubble ($AMZN’s stock went from $106 to $6 from peak to trough) we think the same recovery will occur in online sports betting as the space continues to mature and the path to profitability becomes clearer for the long-term winners. Internally, our investments are more focused on the data providers to the sports betting companies hedged with shorts in the unprofitable sports betting operators.
Top 5 stock Picks for 2022
As we look into 2022, our portfolio is built around 4 themes: 1) inflation remaining higher than expected following multi-decade highs; 2) the removal of unprecedented stimulus and subsequent raising of rates; 3) the stock market valuation compressing from record levels; and 4) the acceptance of Covid as endemic.
With this as our backdrop, our top 5 picks for 2022 are: 1) $USO, 2) $KRE, 3) $FB, 4) $GOOGL and 5) cash.
$USO: As noted earlier in our recap of the $XLE, we believe oil prices will continue higher as demand in 2022 could surpass the record levels seen prior to the pandemic while supply remains restricted by environmental concerns. We debated staying with the $XLE for the reasons noted earlier in our recap but note 43% of the ETF is comprised of just $CVX and $XOM which are up 50% and 41% YTD, respectively. This is not the same setup as in 2020 when they were absolutely hated and down 30%/41% respectively versus the S&P gain of 16%. As a result, we recommend the $USO which tracks the price of West Texas Intermediate crude oil as a top 5 pick for 2022.
$KRE: As noted earlier in our recap of $JPM, we believe rates are headed higher and loan growth will pick up as easy money from fiscal & monetary policies get dialed back. We debated continuing with $JPM as a top pick for 2022 given our belief that it is the best run bank in the world. However, we prefer more domestic banking exposure this year to avoid any potential pitfalls from divergent central bank policies globally. In addition, there is the growing risk of international conflict with: 1) Russia over the Ukraine; 2) China over Taiwan; and 3) Iran over nuclear. $JPM has roughly 25% of its exposure to international markets. Super regional banks are certainly an option which is how internally we have created our exposure to the banking sector. However, there is company specific risk. As a result, we recommend the $KRE which is a regional US bank ETF which is well diversified with a 2% position as its largest holding for those investors who want diversified, less risky exposure to financials. Most investors track loan profitability by watching the 10-year minus 2-year or just watch the 10-year as a shortcut. However, we would recommend watching the 5-year minus the 3-month treasury yield which more closely tracks loan profitability. The second factor to watch is loan growth which should pick up with easy monetary and fiscal policies being reduced.
$FB: If you believe in the metaverse, why not invest in the company that has gone “all in” on the space. Facebook’s expense guidance for 2022 is being driven by investments in the metaverse with operating costs for 2022 guided to $91-97B, up ~33% from 2021 while capital expenditures of $29-34B were guided to rise ~66%. However, with street expectations for revenue growth of just 19% this has driven EPS growth expectations to just 3% in 2022. Historically, Facebook has guided conservatively and therefore we believe expense growth will come in lower than expected. Furthermore, the monetization of newer properties such as Reels and Shopping will help drive revenue growth in 2022. Additionally, the stock has a depressed multiple at 22x that is roughly the same as the S&P at 21x. This is due to: 1) expense concerns; 2) ad tracking issues; 3) engagement concerns due to competition such as TikTok; and 4) regulatory pressures from the US and abroad. We believe most of these issues will slowly improve as 2022 progresses resulting in multiple expansion.
$GOOGL: As economies reopen, Google will benefit from Covid affected industries, that comprise 10-15% of revs, fully re-opening by the end of 2022. In 2021, Google suffered from increased regulatory pressure and ad revenue from travel, leisure, and services space still being impacted due to Covid. By the end of 2022, we believe people will adjust to Covid being endemic much like the flu which kills 30-40K people every year in the US. As a result, we believe Google will benefit from the complete reopening of industries that are currently being impacted by Covid. Google also has a CY22 PE multiple of 23x that is only at a slight premium to the S&P at 21x. In addition, Google offers exposure to other high growth themes through its “Other Bets” division such as Artificial Intelligence (DeepMind), Health (Fitbit and Verily), and Autonomous Driving (Waymo.)
Cash: We believe that we will be able to pick up great stocks at much better prices in 2022 and that the value of cash is highly underestimated during periods of turmoil. Despite cash being a poor investment in a high inflation environment, it is probably our favorite investment to start the year due to the flexibility it will give us later in the year to invest at better prices. We believe that in 2022, the S&P will see a significant correction due to: 1) inflation staying uncomfortably high; 2) a Fed that is behind the curve on inflation and more aggressive than expected; and 3) most valuation metrics near record highs that are likely to compress. For example, the market cap of the entire US stock market divided by US GDP is at 1.9x versus a peak during the tech bubble of 1.4x and an average of 0.8x. We would also note that market multiples are typically below average in periods where inflation was over 3%. We plan to invest this cash later in 2022 in a more value-oriented name in a sector such as networking, streaming, or e-commerce.
Best wishes for your investments in 2022,
Dan Niles is founder and portfolio manager for the Satori Fund, a tech-focused hedge fund.