Q4 Zorik Capital Letter: 2024

Partners,

Over the past quarter, the market rallied as investors predicted pro-stock market policy.

Zorik’s strong performance (outperformed the S&P 500 by 753 basis points, and our

benchmark Russell 2000 by 358 basis points) was driven by a combination of stock selection and favorable market trends for value oriented cash flow stocks.

Ultimately, while we like our portfolio, I make a point of not letting short-term returns

dictate our mindset. Though strong short-term performance may seem encouraging, it is

not a reliable indicator of the long-term success of the businesses we own. One of my

great stock market inspirations, the late Charlie Munger, put it best, “Bull markets go to

people’s heads. If you’re a duck on a pond, and it’s rising due to a downpour, you start

going up in the world. But you think it’s you, not the pond.”

Thus, our focus remains on thorough research and disciplined long term ownership in

businesses that can sustainably compound their earnings over time.

Thoughts on the Market

As I write this letter, Warren Buffet holds the largest amount of cash he has ever held:

$325 billion. This begs a natural question: if the greatest investor of all time is heavy in

cash, is there an issue, and should Zorik continue its heavy allocation in long equities?

The answer lies in context, yet also broader market conditions. Buffet’s sales come from

selling specific stocks, namely Apple and Bank of America, for largely company-specific

reasons. However, he believes the Treasuries he’s purchasing will produce higher

risk-adjusted returns.

The recent rally–primarily–has been driven by increasing optimism. Rather than

expanding fundamentals, multiples have led the charge. As depicted in the chart below,

the S&P 500’s forward PE ratio has grown tremendously since its bottom in 2022—now it

sits just under the bubbly-feeling highs of 2021.

To be clear, I don’t think we are in a bubbly environment, yet simultaneously, it’s hard not

to see Bitcoin at $95,000, Dogecoin’s 450% rally over the past year, Nvidia and Palantir’s

200%+ year over year rises, and not be reminded of 2021. Afterall, each is a retail

investor fan favorite—trust me! Friends and classmates ask me daily about these names

(if only I’d bought them!).

Look, I’m not calling for a crash, and frankly I don’t see a catalyst for the excitement to

end. However, I do believe the market cycles chart above is telling: at current, it feels like

we are within the Mania Phase—but given post-election tailwinds, we could certainly see

this “mania” continuing.

Why We Remain Highly Allocated to Equities

Goldman projected $268 of S&P 500 EPS for 2025, which equates to a 22 forward PE

ratio, or a 4.55% earnings yield. As we predict the S&P 500 to have a couple percentage

points of annual EPS growth over the next five years, the earnings yield plus EPS growth

measure is comfortably above the 5 Year Treasury rate of 4.19%.

As more rate cuts hit, these valuations should begin to feel more and more comfortable.

Goldman Sach’s Chief Economist, Jan Hatzius, says “We are penciling in four more

consecutive cuts in the first half of 2025 to a terminal rate of 3.25%-3.5%.”

Thus, while I do see a lot of excitement within the market, I wouldn’t be surprised if we

find ourselves towards the beginning of the Mania Phase (from the graph on page 2) with

more room to run. Afterall, the economy is strong and valuations are fine.

I expect to see a quick and mild correction in the coming months, as the market could use

a cooldown after its most recent rally. Yet, given our primary objective is to achieve

significant alpha versus the market over the span of several years, the best way to do that

is by remaining in equities.

Thus, we continue to look for new opportunities to deploy capital: specifically businesses

which we believe will reinvest their free cash flow effectively, in order to compound

earnings, over the next five years.

Thoughts on the Stock Market Impact of a Trump Victory

Trump’s victory and Republican control of the House and Senate means there will be

change. For one, Trump has signaled further cuts in the corporate tax rate–which he did

in his first term. This will be positive for the stock market, increasing profitability across the

board. Additionally, given Trump has stated his desire to install a rate-cut-focused Fed

Chair, it’s likely that Jay Powell will be replaced once (or even before) his term is up in 2026.

Trump will continue what he started in 2018, planning to institute a broader policy of

tariffs–most notably against Chinese imports at 60%, but also 10% against imports from

any country. Though in 2018, there were minimal inflationary impacts, this policy is more

sweeping, and should thus be more inflationary.

Yet, marked by the market’s post-election rally, there’s one thing investors seem to

understand: Trump runs on a platform built around being a businessman. His pitch, and

the reason he was able to win over many working class voters, was that he was viewed

as being able to “fix” the economy. Though not always linked to economic performance,

the stock market is the most understandable measure of success, and Trump made use of the market’s gains through his first term, flaunting them to voters. In his legacy term,

Trump will likely double down on his stock market focus, aiming to convey and cement his

economic legacy.

Beneficiary of New Political Trends: Railroads

As US politicians, across the aisle, continue pushing the trend of de-globalization, there

will be increased production of products within the US. Railroads provide a more cost

effective, and depending on location, a more efficient transportation method for US-made

goods than other modes of transportation, like trucking. Most railroad tracks were initially

laid over a hundred years ago, and should continue to exist for the next hundred years.

Each line has a near monopoly over its respective route and there are high barriers to

entry against any new lines being built.

Companies like Canadian Pacific Kansas City have seen a 2% annual volume growth rate

over the past decade, leading to annual pricing growth averaging 4%. Additionally, there

are low costs to add additional cars onto existing trains, which thus lead CPKC to see

margin growth from ~20% to ~40% over the past two decades.

While these historical FCF behemoths continue to buyback shares, they are now

benefiting from vast ‘build in America’ tailwinds. Especially after struggles during COVID,

due to the inflexibility of railroads, and the consequent lack of revenue or profitability

growth over the past five years, railroads should be turning a corner and be set up for a

long bull-run. While I have not yet identified a railroad business I would like to own, I am

currently researching a variety of railroad business with the intention to invest in one that

proves to be a long-term free cash flow compounder.

Wrapping Up

We are excited to continue managing your money and look forward to finding new investment opportunities, staying committed to businesses that focus on and have proven they can effectively compound their capital over the long term as we hold ownership for years to come.

As always, thank you for your support and trust!

Blake Zilberman