• What can we expect after a stock falls sharply?
  • How to think about earnings numbers…
  • Is now the right time to buy?

Dear Reader,

Welcome to our weekly mailbag edition of The Bleeding Edge. All week, you submitted your questions about the biggest trends in technology. Today, I’ll do my best to answer them.

If you have a question you’d like answered next week – especially if it’s about the current investing environment – be sure you submit it right here.

And there’s one other item I’d like to make readers aware of…

We’ve seen capitulation across the board following last week’s Fed meeting. Stocks have tumbled. And digital assets haven’t escaped unscathed either.

As investors, we want to know what to do in times like these. After all, asset classes like bonds are collapsing and even gold – which was long thought to be a safe haven at times like this – has declined as well.  

Worse yet, sitting in cash is a terrible solution as well for the same reason – we’re losing over 8% of our purchasing power from inflation if we do.

So it can be difficult to know where to put our money.

Yet there’s one asset class that is capable of being an inflation hedge… and more than that, it can even grow our wealth while the rest of the market is sinking.

I’m talking about private investments.

I’ve spoken about private investing before… but that message has never been as important as it is now.

Private investments are immune to most of the troubles the stocks in our portfolio are experiencing right now. As long as private companies execute their plans and keep growing, their value will increase with each funding round.

And there’s one particular kind of private investment that’s giving investors the chance to build a fortune despite the volatility. I call them “crypto placements.”

As I mentioned earlier, even digital assets have suffered lately. Yet these crypto placements can give us exposure to this explosive growth trend at the most attractive valuations, while at the same time protecting us from the red days of the publicly traded crypto markets.

I know it’s uncomfortable to sit through these times. I’m in the same boat, and live and breathe the markets every day. 

And that’s why I want to share my perspective on this asset class with readers now. It is the one place in my own personal portfolio that not only doesn’t have me worried – it’s an area that has been increasing in value despite the pullback in the public markets.

I’m going to host a special event coming up on May 18 to talk all about how we can take part in private investments – even if we aren’t an accredited investor – and what makes crypto placements so promising at this current moment.

I’d like to invite all my readers to attend. Especially if you’ve been losing sleep over seeing the red in your portfolio, I’d encourage you to tune in to this event.

Simply go right here to sign up for free. It’s all happening on May 18 at 8 p.m. ET.

Can stocks recover from deep in the red?

Let’s begin with a question on falling stocks…

Hi, Jeff. If you expected a stock to rise to a particular price when you recommended it, and the stock then dropped 70%, do you expect it to rise to the initial price you recommended? It would be very useful if you could be clear on that in your stock updates (for each stock).

Thanks as always!

– Gordon E.

Hi, Gordon – thanks for being a subscriber, and for sending in this question.

I know it has been awful the last couple of weeks as the entire market has sold off heavily. This is one of the most complex environments I’ve seen in my 30+ years of being an investor.

In fact, I have rarely seen companies this oversold. Many are even trading for less than the cash they have on their books. It’s absurd. And it’s all being driven by the actions of the Federal Reserve with regards to rate hikes, “threats” of quantitative tightening, and inflation fears.

But whenever we start to see deeply depressed valuations, the market always steps back in to buy. And I’ve already seen some large institutional buying begin. We’re not out of the woods yet, but it always starts this way.

To answer your question, the most relevant metric for us as investors to understand is the valuation of the company. Whether a stock has dropped 30% or 70%, what I’m watching most closely is what the valuation will be once the market returns back to “normal.”

This is determined by a variety of factors that include the forecasted revenue growth, the gross margins of the company, the company’s free cash flow, competitive positioning in the market, and future product/service development plans. 

As long as our original investment thesis is intact, these companies will see a dramatic rise in valuation, and in time, will return back to levels that I originally predicted at the time of my original recommendations.

From my perspective, the only time to sell is if we see a material change in our investment thesis. I hate to see normal investors get whipsawed by all of this large hedge fund money that is quickly shifting out, and then back, into assets. What we are seeing right now is a lot of forced selling from funds, which has resulted in an oversold market. 

It is very frustrating to have to endure the volatility, but a little patience will go a long way. Typically, when we see a sharp correction like this, the recoveries tend to be faster.

As always, I’ll continue to update readers as the market conditions evolve.

Understanding the growth of small-cap stocks…

Next, a reader wants to know more about our metrics…

Dear Jeff, I am a member of your Unlimited service and enjoy it. I do have one question. In all your reports, revenue plays a big role, as does the price-to-sales (P/S) ratio, and EBITDA (earnings before interest, taxes, depreciation, and amortization). However, you do not say much about earnings.

In fact, most of the stocks in the Exponential Tech portfolio have negative earnings. Of course, that is the nature of a nascent company.

However, you tell your subscribers that you are identifying the point at which the company is poised to grow exponentially. Wouldn’t one expect a company at that stage of its life to already be profitable? If not, why not, and if so, could you please explain why so many of the companies you recommend are not?

– Gordon E.

Hi, Gordon, this is an interesting question.

Earnings, as in net income, is an accounting measure and not necessarily a direct reflection on the health or growth of the business. And because it is an accounting measure, it can also be manipulated on a quarter-by-quarter basis.

It can be kind of useful for very large, well-established businesses, but net income and earnings per share are still imperfect. For larger businesses, using EBITDA as a measure is far more useful. And even better than EBITDA is the free cash flow that a business generates.

Free cash flow is the actual cash that a company is generating, and cash that can be used to further invest in growing the business. Companies can have negative earnings and be unprofitable but still be generating a lot of free cash flow.

Amazon is a perfect example. Amazon for years was “not making any money” and “a terrible business” to some. But it was throwing off free cash flow, which was used to reinvest and grow one of the greatest businesses in the history of the world. 

Even Warren Buffett misunderstood the value of Amazon because he was myopically focused on “earnings” instead of free cash flow.

And for high-growth companies, strong gross margins, healthy EBITDA, and growing free cash flow are far more important than “earnings.” As long as a growth company is generating in free cash flow, it will have the capital to continue to invest and grow its business. 

And if it has the ability to smartly invest that cash flow into even more growth, I would much rather the company does that than consider paying something like a dividend. The investment returns will be so much better with growth, compared to dividends.

In Exponential Tech Investor, I have a mix of companies that are generating free cash flow and those that are on their way to reaching cash flow breakeven.

For smaller, high-growth companies with many multiples of investment return potential, whether or not they are generating net income or “earnings” simply isn’t important. If they have enough cash on their balance sheet, and/or have a path to free cash flow breakeven, then there is a very clear path towards a dramatic increase in valuation.

My strong preference for these kinds of companies is to generate free cash flow and invest that cash flow in even more growth for the business.

Large-cap, well-established companies that are generating free cash flow, that pay dividends, is an indication that growth has already slowed. They have no better use for the cash to grow, so they pay out a portion of those “earnings” as dividends.

We do tend to see strong inflection points in a company’s growth when a company reaches free cash flow breakeven, and then demonstrates a path towards consistent increases in free cash flow year after year. It is an indication that a company has really hit its stride in its go-to-market strategy and product/service offering. 

Ideally, it is good to invest in companies just before that happens. It’s a great way to invest ahead of the largest investment gains.

So in summary, it is OK if a company isn’t yet generating net income or “earnings,” as long as it has a clear path towards free cash flow breakeven and increasing gross margins. And on occasion, I’ll recommend pre-product revenue companies where even free cash flow doesn’t really matter. 

These kinds of companies present unique opportunities as they are developing a technology or product that has the potential to become a breakthrough in their industry. When that happens, the most likely outcome is that the company is acquired for a large premium.

Thanks again for the question. Each asset class is different, and the investment strategies in each class also have their differences. 

Applying one rule to everything isn’t appropriate, and can even lead to making bad decisions. It’s great to explore these differences.

Bringing Outlier Insights to readers…

Let’s conclude with a question about the newest addition to the Brownstone Research roster… Earlier this week, editor Jason Bodner launched Outlier Insights, a free e-letter where he’s been sharing his take on the recent market action.

So for the last question today, I’ll turn it over to him…

I appreciate your wisdom and insight on how to best move through these times. It would seem to me, if one believes as you do, that now is the best time to buy into the future by buying at bargain prices.

Also, I always like to know the worst-case scenario and how to know when that is where we are headed and what might be the best way to survive it. Thanks,

– Geoff G.

From Jason:

Hi, Geoff. Thanks for writing in.

Investing decisions are unique to each individual, which is why I can’t give personalized financial advice to readers. But I can share my perspective.

My timeframe – especially when it comes to my kids – is long-term. So that’s why I am buying on these outsized dips in stocks.

While it’s a fearful time, I am confident the companies I am investing in will be around in the years to come. If they are trading at lower prices today, they will likely trade higher prices in the years ahead.

I am highly confident the equity market will be higher five years from now. So If I buy today, but tomorrow I’m “losing money” because my investments went down in market value… I’m fine with it.

The valuation speculation going on now is in response to uncertainty. But these things invariably work themselves out over time.

I’m a fundamentally positive person and optimistic about life. I’ve lived through many financial catastrophes and several personal ones. I’ve survived a distressed plane emergency landing with oxygen masks. I’ve survived 9/11. I’ve survived a tsunami. I’ve survived near insolvency. What we are going through now doesn’t compare to those hardships.

This is fear and emotion manifesting itself on the risk asset market. And I still believe it’s what the Fed wants. The more money that comes out of the system by inflation and lower asset prices (stocks and crypto), the less there is to chase goods (discretionary spending).

That way, inflation resolves naturally without the need for a lot more Fed policy. The Fed has – and will – continue to raise rates for now, but the market is doing the heavy lifting for it.

And in terms of identifying opportunities… a deal in the market rarely looks and feels good. In fact, it’s the opposite.

It’s when fear and despair are highest that the best opportunities present themselves. Titans like Warren Buffett know this well. That’s why he is fearful when others are greedy and greedy when others are fearful.

So I am identifying long-term deals and acting bit by bit on them.

Plus, my Big Money Index – how I track institutional buying and selling pressure – is about to go oversold, which is a very bullish indicator near term.

I believe in humanity and America. That’s why I invest when things look bad. We’ve been through immensely worse times and have thrived every time thereafter.

I know it’ll be the same this time too.

And I’ll talk more about what we can expect from these markets – and when exactly the data shows us hitting bottom – in Outlier Insights, my new e-letter.

If you’d like to receive it for free, you can sign up by going right here. Currently, we publish new content on Mondays, Tuesdays, and Thursdays.

And if there are any topics readers would like to see me address, you can write in right here: [email protected].

– Jason Bodner

That’s all we have time for this week. If you have a question for a future mailbag, you can send it to me right here.

Have a good weekend.


Jeff Brown
Editor, The Bleeding Edge

Like what you’re reading? Send your thoughts to [email protected].