We are at the beginning of the earnings season again here in the US. In this week’s article, we will be discussing three things:

  • Tesla’s earnings
  • Netflix’s earnings
  • The most profitable companies in America you never heard of before
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Tesla’s Q3 2020 Earnings – strongest quarter ever

Three key takeaways from Tesla’s latest earnings report:

The first takeaway

Tesla reported its strongest quarter ever. The company generated US $7.6 billion, which is a 39% revenue growth year-over-year. Beyond this top line number, two of Tesla’s most important metrics for investors are car deliveries (the primary way it makes money) and operating cash flow (to continue to fund operations and factory build outs). This past quarter Tesla delivered 139,593 cars, which is also a record, while generating US $1.4 billion from operations. We summarize the trends for these two numbers in Figure 1 below.

Figure 1: Tesla’s quarterly car deliveries and operating cash flow. Data is from the company.

The second takeaway

Tesla continues to gain efficiency in China. It reduced the selling price of the Model 3 in China to RMB 249,900 after incentives (or around US $37,300), undercutting other premium sedans (Mercedes C-Class, BMW 3-series, Audi A-4). Even though most cars made in its factories are for sale in the local market where the factory is located (see Figure 2), this may change soon. Tesla will use China as a low-cost manufacturing base and will start exporting cars made in Shanghai to other countries. This will in turn help profitability. You are already seeing this effect – the GAAP margin this past quarter is 23.5% (4.6% higher than the same period last year).

Figure 2: Percentage of deliveries made to local markets where the factory is located. Data is from the company.

The third takeaway

Since it is profitable, Tesla is eligible to be included in the S&P 500 index, even though it was shunned by the index a couple of months ago.

Note that to be included in the S&P 500, Tesla must achieve two things: (1) post positive profitability in any 4 sequential quarters, and (2) its most recent quarter must be profitable.

Netflix said that their 2nd half growth will be slower – but investors didn’t believe them

Three takeaways from Netflix’s earnings:

The first takeaway

For Q1 earnings this year, Netflix told investors that they pulled forward a lot of subscribers growth due to the lockdown, and that they expect growth in the second half of 2020 to be slower than normal. After all, if a global pandemic and lockdown does not push you to sign up for Netflix, not much will….That is exactly what happened. As quoted from a letter by the management:

“As we expected, growth has slowed with 2.2m paid net adds in Q3 vs. 6.8m in Q3’19. We think this is primarily due to our record first half results and the pull-forward effect we described in our April and July letters. In the first nine months of 2020, we added 28.1m paid memberships, which exceeds the 27.8m that we added for all of 2019. In these challenging times, we’re dedicated to serving our members.” — taken from here

As a side note, if you have never read Netflix’s investor letters, we highly recommend you do so – it’s an easy read compared to some other companies we’ve looked at (we are looking at you Uber…).

Investors were disappointed with the latest subscriber growth numbers, which resulted in a drop in the share price. At this writing, Netflix’s share price has dropped more than 7%.

Is this a big deal in the long term? Unlikely. Figure 3 plots Netflix’s quarterly subscriber growth vs. its share price (share price at the end of the month of earnings release). In the past 19 quarters, Netflix has missed 5 growth forecasts (red dots), while beating 14 forecasts (green dots). Overall the management has done a good job in predicting growth (or has been throwing itself softballs). In the meantime, the share price has been more than quadrupled. 

Figure 3: Netflix’s quarterly yearly subscribers addition and share price after earnings release

The second takeaway

Nearly half of new subscribers come from the Asia Pacific (APAC) region (Figure 3). As a result, APAC revenue went up 66% year-over-year. This growth is propelled by increased penetration in South Korea and Japan (up to double digit penetration for broadband homes), undoubtedly thanks to the company’s investments in local content (especially Korean drama and Japanese Anime – these types of content travels well outside their home countries). 

Figure 4: Netflix’s new subscriber growth in Q3 2020 by region.

The third takeaway

Netflix continues to improve its operating margins. The company is forecasting full FY20 operating margins to be 18% (previously, it was forecasting 16%). This is more than 4X higher than in 2016, when it was about 4%. We discussed Netflix’s strategy in greater detail here, but in short: because Netflix has the largest global subscriber base, it can afford to pay a lot for any piece of content (fixed costs), which it then spreads out to a very large number of subscribers. It is very difficult for smaller competitors to compete against Netflix’s scale advantage.

The most profitable companies in the world you probably have never heard of

In the great California gold rush of 1849, hundreds of thousands of people came from all over the world to settle in California to mine for gold. San Francisco grew from a small settlement of roughly 200 people (in 1846) to a booming town of about 36,000 (in 1852). However, most of these miners did not generate enduring wealth.

The folks who profited the most from this gold rush were sellers of goods and equipment. Chief among them was Levi Strauss, a Bavarian immigrant who sold equipment and durable clothes (made of tent canvas) to miners. His company still endures today as Levi Strauss & Co, the maker of laser-induced faded jeans….

This is a roundabout way of saying, oftentimes, the better business is to sell pickaxes and jeans during a gold rush, just as it was better to sell GPUs and ASIC chips during a crypto bubble (see Nvidia’s and TSMC’s share price during the crypto bubble).

With increasing penetration of equity investing globally, some of the companies that capture the most value are the owners of the exchanges. They make money from trading, clearing and selling data, and they are some of the most profitable companies in the world. See Figure 4 to see the Net Income margins of these companies vs. the largest internet giants of the world (FAANG plus Microsoft).

  • Intercontinental Exchange (ICE) owns NYSE.
  • The CME group owns the largest financial derivatives exchange and does asset trading.
  • Nasdaq Inc. owns the Nasdaq exchange and the index.
  • S&P and Dow Jones are partially owned by the Chicago Mercantile Exchange.
Figure 5: Net Income Margin of Exchange owners (Intercontinental Exchange, CME Group, CBOE and Nasdaq) vs. Facebook, Apple, Microsoft, Google, Netflix and Amazon.

This article is meant to be informative and not to be taken as an investment advice, and may contain certain “forward-looking statements,” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, without limitation, estimates with respect to financial condition, market developments, and the success or lack of success of particular investments (and may include such words as “crash” or “collapse”). All are subject to various factors, including, without limitation, general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors that could cause actual results to differ materially from projected results.

Our team members at Vested may own investments in some of the aforementioned companies. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for an investor’s portfolio. Note that past performance is not indicative of future returns. Investing in the stock market carries risk; the value of your investment can go up, or down, returning less than your original investment. Tax laws are subject to change and may vary depending on your circumstances.

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