With earnings season about half-way over, most companies in our portfolio have reported. In terms of post-earning reactions, our portfolio stocks have a lot of strong performances (the likes of Morgan Stanley or AMD), but also do not fall short of underperformers (such as Ford or Boeing). Reflecting on what the stock market has rewarded versus punished, in today's post, we would like to add another layer to our primary investing theme for 2022.

Our investing theme — first detailed at length on 17 Dec here  — is to buy companies that make things and sell them profitably, while staying away from unprofitable, more speculative stocks as the Federal Reserve tightens monetary policy. 

Now, what we realize is that not only do our companies have to make a profit, they have to have excess demands that they can raise prices in the face of inflation. It’s necessary to add this layer of selection because the hot-growing U.S. economy requires aggressive (hawkish) monetary policy from the Fed to control inflation. Until inflation comes under control, what matters for companies is how they deal with inflation versus other companies. 

"Can you raise prices? Can those prices stick because there’s such demand? Can you outrun not only your raw costs, your supply problems, but the competition as well?" These are the questions you would like to ask your companies. Investors need to place a greater emphasis on the level of demand for a company’s product. If demand exceeds supply, the company can raise prices and to generate bigger profits.

Amazon vs Walmart

These two retailers offer a case study of their different abilities, or the willingness thereof, to raise prices. On Friday of last week, Amazon shares surged greater than 10% in a single day after they announced they would increase the cost of Prime membership more than 10%. This speaks to their ability to raise prices as they are confident their membership product has such strong demands. On the other hand, the stock of Walmart has been doing nothing for the past year because of the following problems: spending too much but seeing little progress, and they are having a tough time dealing with higher input costs. Walmart is a retailer who takes in supply and sell them at a profit to customers. When the supplies get more expensive, yet they are uncertain and unwilling to raise prices, those profits decrease. That's what Walmart has been struggling with, a problem that Amazon certainly doesn't have.

Ford, General Motors

Ford or General Motors as traditional automakers is a case in which their profits are being hurt with higher costs. On the latest earnings report, Ford mentioned an increase of commodity costs of $1.5 - $2 billion during the first quarter of 2022, and other unexpected inflationary pressures. This puts pressure on the profitability of the company. Unless the company is able to pass higher prices onto customers (which we think Ford will have no problem to do with strong demands for their products), market will continue to punish the stock. 

Clorox

Shares of the cleaning products maker tumbled 14% on Friday after it reported a sharp decline in second-quarter gross margins and lowered its full-year outlook. This is a case of having much lower demands (compared to the past 2 years when virus infections were of bigger concerns) and way too much products.