Evolution AB

Selling out!

I bought Evolution in the dark days of 2022 when every digital business was down in the dumps due to sharp increases in interest rates. Since then, everything technology has picked up. Evolution, however, has barely budged. 

This has been a huge disappointment. It has been a long time since I have seen a business with better financial metrics. Revenue growth is fairly strong. Profit margins are among the highest in the world in relative terms. The company is also cheap on a forward-looking net income basis. The dividend grows by 50% on an annual basis.

So, why does the stock keep on lingering? I have tried to find answers but I am still trying to understand. One explanation could be that Nordic investors don’t want high-growth companies because they are skittish about inflation and high interest rates. Another reason could be that investors don’t want to invest in gambling. I have also seen the Swedish press warn about an imminent growth slowdown and questionable accounting strategies. Among bloggers, more exotic explanations are also swirling around, for example, that live studios are under Putin’s thumb in Georgia. 

I don’t believe in any of these more exotic explanations. Evolution has live studios scattered around the globe and has few competitors. Accounting malpractices are harder to process critically. I have some formal schooling in accounting and have perused the accounts to the best of my ability, but quite frankly, I haven’t found anything weird. In addition, the growth is still strong based on the recent quarterly reports, so I am puzzled by what the Swedish press bangs on about. 

The bottom line is that the stock doesn’t work. It must have something to do with the general sentiment. For one reason or another, investors don’t want the shares. This is the only thing that matters at the end of the day, even though it is puzzling that peer companies in the gambling space, like Flutter and DraftKings, have done quite well. In any case, it is what it is. Sometimes you have to listen to the market. The market doesn’t care about my views and the fact that I mean that a fair price for the stock is between 1400 - 1600SEK.

Well, that was it then. Not everything I touch turns to gold. In one and a half years, I have a total return of 10% in the name,  so it’s not a catastrophe. However, the return pales compared with Uber and Salesforce which I bought more or less simultaneously. I want to apologize to all my readers who potentially have followed me into this name, and now, try to figure out what to do with the stock. As a final note, I would like to say; that there is nothing wrong with making mistakes in the stock market. I am going to make many bad investment decisions in the future. The biggest sin in finance is to stay wrong. When the facts change, change your mind, as Keynes pointed out a century ago.

Portfolio construction

Portfolio construction is an ongoing debate within finance, Most fund managers run portfolios with around 40 stocks. In most cases, their stock picking is driven by relative valuation. They try to weigh different stocks within a sector, and then they try to pick the best one. 

I am skeptical of this investment philosophy. It doesn’t take much before the totality of the portfolio starts to mimic overall market performance. Furthermore, empirics show that fund managers have trouble beating the market. There is a lot of closet indexing going on.

My philosophy is to run a concentrated portfolio of around 15 stocks. There are mainly two reasons why I chose this investment style. The first is practical reasons. I cannot follow 40 stocks closely. This means reading 40 earnings reports every quarter, listening to 40 earnings calls, and keeping tabs on multifold company news. In addition, you have to follow the vagaries of the market, research new candidates for your portfolio, etc. Usually, fund managers have a team around them to do this job. I am a sole operator and don’t have this capacity.

Secondly, I have no interest in copying market performance. Misinterpret me right, I also save in index funds, but I keep the two strategies separate. My fund investments are about 20% of my overall investment portfolio. Here I dollar-cost average into my funds and let them run on autopilot. The rest of my portfolio is subject to thinking, analyzing, strategizing, and individual stock picking. By doing it this way, I capture the best of two worlds. I am guaranteed market performance in the index funds, while I can create alpha in my stock picking. Trying to achieve stunning returns is the fun part of investing.

Alas, 40 stocks are too hard to follow up, 15 stocks are fun. The only thing you must be aware of doing it this way is that the risks are high. You must be comfortable with making mistakes, underperforming in periods, and taking occasional losses. So, you must be careful, research companies properly, and continuously hone your investment skills. 

On the chopping block

After the sale of Evolution, I own 17 individual stocks. My portfolio has sprawled because I have received many spin-offs from larger holdings as part of special dividends in the last two years. There is nothing wrong with any of these spin-offs. They are all good companies paying out good dividends. Partly as a result of these dividends, and partly as a consequence of laziness, I have kept these stocks in my portfolio. This summer, it is time to do some portfolio clean-up. Here are the companies on the chopping block. 

Mandatum is a spin-off from Sampo. However, Storebrand is already a core holding in my portfolio, and I have no interest in owning two life insurers. I have nothing negative to say about the company, it just has no use in my construct. 

Nordea is also a spin-off from Sampo. The bank is the largest in Scandinavia. Again there is nothing inherently wrong with the company, it is just so that I have no interest in owning banks. 

Sampo is still a core holding in my portfolio. It has given me great dividends throughout the years, and Sampo is using the funds from these spin-offs to finance greater market shares in the Danish and British markets. Damage insurance is a stable and profitable business.

Organon is a spin-off from Merck. These days, it is fashionable for big pharma to spin out their generic drug businesses. GSK has spun out Haleon. Pfizer has spun out Viatris. These biosimilar drug businesses are stable but have lower profit margins than their mother companies, and are mostly of interest to investors seeking high-yielders. It doesn’t fit my investment style, so I have no interest in being a long-term shareholder in these names.

New Prey

By doing portfolio clean-up, I have room to invest in new positions. In the last few weeks, I circled software companies like a vulture. Finally, I decided to add to my Salesforce position. Nowadays, I am circling myself in on various cybersecurity and AI-ready storage companies. You will likely hear about a new purchase in this area in the upcoming weeks.

Disclaimer: Important Information for Retail Investors

The information in this blog is for educational purposes only, not financial advice. Investing in stocks carries risks; past performance doesn't guarantee future results. Conduct thorough research and seek advice from financial professionals before investing.

The author is a retail investor, not a licensed advisor. Content accuracy isn't guaranteed due to changing market conditions. All investments have risks, including the potential loss of principal. Assess risk tolerance and goals before investing; diversification is key to managing risk.

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