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In 2014 Cathie Wood founded her own investment firm called Ark Invest, which now manages a staggering $60 billion. In 2020, while the S&P was up 17% and the Nasdaq up a staggering 43%, her ARKK Innovation ETF skyrocketed 151%. Since inception, her flagship fund is up 225% while the S&P only returned 146% and the Nasdaq 212%.

But recently, it’s no secret her fund has run into problems. Over the last two years her fund returned 19% while the S&P 500 and Nasdaq climbed 26 and 29 percent respectively. Has she lost her touch? Or does she see something traditional portfolio managers have missed?

Cathie recently spoke about the current economic conditions given the backdrop of the Russia Ukraine war and detailed her economic outlook and investment thesis. In this video we will discuss her thoughts and some of her recent trades.

Before discussing her economic views, we must discuss her investment thesis, which will help explain her recent performance. As Cathie Wood puts it, her flagship innovation fund invests in disruptive companies. These companies have technological innovations that could potentially change the way the world functions. Think of it as choosing stocks that will become the next Google, Amazon, or Meta. Recent examples of this would be Coinbase, Snowflake, and Crowdstrike.

However, these stocks can trade at expensive valuations. Innovative stocks trade at a high price to earnings multiple or PE ratio. The price-to-earnings ratio is often used as a comparative metric, but it can also be thought of as the number of years it takes for a stock to return the entire market cap. For instance, if a stock has a PE ratio of 30 and earnings were constant, it would take 30 years for the company to earn the amount of money invested. If you invested $100 in a company with a PE ratio of 5, the company would earn $100 for your equity after 5 years assuming all the variables are constant.

ARK’s analysts frequently compare PE ratios against companies in the same industry. For instance, you would not compare a utility company’s PE to a retail or software company. This is because each industry has different tailwinds, capital structures, consumer behaviors, etc.

Google is a perfect example of Cathie’s philosophy. In 2005 Google was an innovator and traded at a premium valuation. It traded at a 50 times price to earnings ratio while the Nasdaq traded at 25 times earnings. Based on Google’s PE ratio in 2005, you would think the Nasdaq would have been the better value as the Nasdaq was 50% cheaper, but that’s definitely not the case. In fact, it actually took several years for Google’s stock price to trade at roughly the same PE as the market.

Cathie is patient and is focused on the long-term, and the price to earnings does not include the expected growth of the earnings.

Cathie Wood looks at the price to earnings to growth rate or PEG ratio. To understand this we need to compare two stocks. Stock A is trading at $25 and has earnings of $1.00 per share. Stock B trades at $25 and has earnings of $1.00 as well. Both trade at 25 times earnings or 25 PE. They appear to be the same value, but they aren’t if earnings growth rates are different.

If stock A is expected to grow earnings at 10% per year and stock B at 50% per year, then analysts will have to make an adjustment to the P/E ratio. This is done through the PEG ratio by dividing the price to earnings multiple by the growth rate. The 5-year expected annual growth rate is typically used. In this case, company A’s price to earnings to growth rate, or PEG, is 2.5x while company B’s is 0.5x.

This is one of the items Cathie Wood looks at. She is not looking at just the current earnings multiples, but rather the PEG ratio out 5 years from today. Turning back to our Google example, it might look like investors in 2005 would have been better off owning the Nasdaq, but this can’t be further from the truth. Since April 2005, Google returned 2532% while the Nasdaq returned 548%. In fact, Google almost doubled the 13% annual return of the Nasdaq. This also includes the recent covid crisis and Ukraine/Russian war.

Investors should be looking for the next Google, and that’s exactly what Cathie Wood is looking for. She focuses on innovative technology which means her stocks will have a high PE ratio.