Brick By Brick Capital Mid-Year 2022 Fund Letter

Thoughts on the market

This has been one of the hardest and most difficult markets ever. The mixture between a re-opening economy, massive waves of fiscal and monetary stimulus, highest inflation in decades, the largest scale war in continental Europe since WWII, and an ever developing pandemic has led to the stock market having the worst start to a year since 1970. This is to give more context about the environment which we have been operating in.

This widespread damage has even hurt the most seasoned investors. This is highlighted by the many famous large Hedge Funds being down greater than 40% through the mid-way point of the year. In some cases 60% and in other cases some closing their doors for good. I want to highlight this to showcase even the best professional money managers with decades of experience are having trouble navigating this market. Again, to give further context of the environment we are operating in.

So what’s next?

Well, many market participants believe the United States is headed into a bad recession. Why? Because the Federal Reserve will be forced to continue to raise interest rates in order to cool off demand and bring down inflation, BUT in the process will be cooling off an already cooled economy creating a tailspin sending the United States economy into a bad recession. Now what is a recession? Well, by the technical definition it is 2 consecutive quarters of negative GDP growth and this has already happened, as 1Q GDP was negative and more recently the 2Q GDP read was also negative. So now the question is, how bad does this recession become?

How I see it

While I did believe it was likely we would reach a technical recession, I believe that the market is being overly pessimistic and is pricing in a 2008 GFC level recession. I point out three major differences between now and then:

1. The job market is extremely strong, there are more job openings than job seekers.
2. Consumers are not over leveraged and don’t have astronomically high levels of debt like they did leading into 2008.
3. Along with the consumer, businesses have high levels of cash and are not over leveraged like they were leading into 2008.

So what does that mean?

While the market has had a nice bounce over the past few weeks, I think ultimately we will see a final “flush” in the early fall before the midterm elections. A flush is a move lower and I think we will either retest or make new lows on a market wide basis sometime in the early fall time frame. BUT WAIT; didn’t you say the market was being too pessimistic? Yes, but the recent rally has been overdone and been fueled by positioning and short covering rather than a fundamental bottom of a bear market. Often the largest market bounces come within the heart of the most vicious bear markets. I think this pessimism will worsen into the fall as more negative economic data rolls in, causing a move lower.

My plan going forward

I plan to continue to keep a high level of cash on the sidelines (>30%) and concentrate the portfolio to only the highest conviction names until I believe the smoke has cleared. At which point, I will be very aggressive in buying high quality growth companies. In the near-term, I plan on adding to oil related ideas along with my highest conviction names. I see the recent pullback in oil stocks as an excellent entry opportunity for long-term investors.

The drop in oil stocks has been fueled by a belief we are headed into a massive recession that will cause demand destruction of oil and the byproducts of it. As I stated earlier, I do not believe we are headed into this type of recession. In addition to this, I am of the belief that the structural shortages in our domestic oil market, and more broadly the world’s energy market, will continue over the next few years causing a continued tight energy market therefore resulting in higher oil prices and more profits for oil companies.

Finally, for those accounts that have margin and are able to short, I will be shorting companies with broken business models, EX: Robinhood (HOOD) and companies who artificially benefited from Covid-lockdowns and stimulus benefits.

My investment strategy

I am a GARP investor focused on “Millennial tech” who focuses on under-followed small-to-mid-cap companies. Now let’s break that down into simpler terms.

GARP

Stands for Growth At Reasonable Price; I want to find growth companies that aren’t absurdly expensive. For a quick example, a common ratio that I would use determine if a stock is expensive is a Price-To-Sales Ratio (P/s). What it means is for every $1 the company makes in sales what does the stock market value it at. So if a company has a 3x P/s ratio that means for every $1 in sales, the stock market values that as $3. If it’s a 0.75x P/s ratio, than every $1 in sales the market values it at 75 cents. If it’s a 20.5x P/s ratio, than every $1 in sales the market values that at $20.50.

I do not impose a generic rule of what I will or won’t buy in regards to a companies’ valuation. However, I do pay close attention to the valuation the stock market is assigning a company and compare it to what I believe to be the growth prospects of the underlying business is. If I believe that the valuation is reasonable, or undervalued, that would be a green light to buy the stock.

What is millennial tech?

It is a term I have coined to describe the type of companies I research. It is disruptive technology that is changing the status quo of a given industry. For example – PagerDuty (PD) with digital business operations, Schrödinger (SDGR) with drug discovery or Airbnb (ABNB) with the lodging industry. This definition casts a wide net in terms of what sectors I look at, but it is very specific in terms of what type of companies I look at. I also believe focusing on these companies gives me an inherit edge over Wall St. as they are often older and disconnected from what is truly innovative.

Small-to-mid cap companies

This refers to the size of the underlying company and specifically companies whose market capitalization are under $10 billion. Now $10 billion is a huge number, but for example Airbnb has a $74 billion market cap, Salesforce (CRM) has a $189 billion market cap, and Apple (AAPL) has a $2.67 TRILLION market cap. Yes, trillion.

These small to mid cap companies are often under-followed by Wall St. and therefore lead to opportunity to make money. This is because the lack of coverage creates fundamental misunderstandings about the businesses, which then creates a divergence between the stock price and underlying business prospects. Also, many investment managers cannot own these smaller stocks due to their own mandates, which I feel gives me an inherit edge as there are less eye-balls on the name and therefore information gaps that I can uncover.

Many assume there are a multitude of factors that make stocks go up or down, when in reality it all boils down to one singular thing.

Expectations versus reality.

I believe my investment philosophy leads me to find stocks where the expectations are too low versus what the likely reality is.

How to compare the fund’s performance

While the nominal performance of the fund has not been up to my standards, it is important to understand how to compare my performance. In the investment world, benchmarks are used to determine relative out/under performance by an investment manager.

In simple terms, a benchmark is what the investment manager aims to beat. If the benchmark is down 10% and the fund is down 4% that is a relative outperformance of 6%. If the benchmark is up 45% and the fund is up 34% that is relative underperformance of 11%.

The main benchmark for Brick by Brick Capital is the ARK Innovation ETF (ARKK). Both the NASDAQ 100 (QQQ) and the Vanguard Mid-cap Growth (VOT) are also used as secondary benchmarks to gain an even better understanding of my performance. All three benchmarks were down significantly through the first half of the year with ARKK down 56%, QQQ down 29.5%, and VOT down 30%. My aim is to beat all three benchmarks, regardless of market conditions, over the 3/5/10 year horizons. On a shorter time horizon though, in bear markets I aim to underperform ARKK by less and in bull markets aim to beat QQQ/VOT.

Performance

Posted below is the performance of our benchmarks and Brick by Brick’s overall performance through the mid-year point and through the month of July. This number is calculated by summing all the returns from each individual portfolio.

YTD Performance Through	June 30th (mid-year)	July 30th
BxB Overall Performance	-22.13%	-17.33%
Ark Innovation	-58.00%	-52.99%
Mid Cap Growth	-30.50%	-23.23%
NASDAQ 100	-29.50%	-20.95%

Click to enlarge

Final Thoughts

The seriousness, which I exhibit in being a shepherd of your investments, could not be higher. I am invested in these stocks right beside you. Meaning, that I invest my own money in the same companies that I invest in for you, I am putting my money where my mouth is. I watch over the positions on a daily basis and revisit/test the thesis as to why a stock is in the portfolio on a weekly basis. Our portfolio is the first thing I think of when I wake up in the early morning hours and it is the last thing I think of when I put my head to my pillow at the end of the day.

I am constantly reevaluating our positions and I am quick to change my mind if for example the thesis breaks or broader market forces change. That happened with a past position Aspen Aerogels (ASPN). Many of you bought the stock in the low $30s to high $20s. I eventually exited everyone from the position in the mid teens for a loss of ~30%. I exited the position because the market sentiment towards high growth “story” stocks like ASPN completely soured along with their need for a capital raise was too much risk.

Roughly a month after selling the stock, ASPN fell ~40% in a day to the single digits on an announcement of an extremely dilutive capital raise. The point of the story? I remain vigilant on your portfolios and while loses are never fun, I am steering the ship clear of the Titanic size loses that can ruin a portfolio.

I am beyond grateful for the trust you have in me, and I will continue to work every single day to find the next big companies and help grow your money. I will leave you with this final quote from a famous investor regarding mark downturns.

“A market downturn doesn’t bother us. It is an opportunity to increase our ownership of great companies with great management at good prices.” – Warren Buffet