I was excited when I discovered Mohawk (MWK) because it checks off most boxes of a potential super stock. It has a huge breakout with large volume back in April 2020, forward P/S ratio less than 1, rapid revenue growth, enormous operating leverage to expand profit margin, founder-operated business with a strong incentive to increase the stock price and a super theme in AI and eCommerce.
The reason why I like MWK:
- Low market cap $125M with relative low float 15.4M shares
- Low forward P/S ratio = 0.64 with rapid revenue growth and profit margin expansion
- It's at the inflection point - recent quarter is the first quarter that reports positive adjusted EBITDA.
- Enormous operating leverage with economies of scale: small increase in fixed cost as revenue grows
- CEO/CFO/CRO have large # of options exercisable at the price of $9.72
- Recent insider buying on open market
- eCommerce/AI theme
Company Overview
I cannot do a better job to describe what MWK does than the company itself. This is how it puts it in the most recent investor presentation - Mohawk Group Holdings is a rapidly growing technology-enabled consumer products company. Its proprietary AIMEE (AI Mohawk eCommerce Engine) platform leverages data and AI to automate the design, development, and launch of best-selling consumer products:
- Identifies new market opportunities
- Launches new products
- Automates marketing variables
- Analyzes and optimizes owned and operated consumer product brands
The company has identified the secular trend of declining value of brand recognition in the context of eCommerce - customers do not begin their product search by searching specific brand names; instead, customers rely on reviews and compare prices to make their purchase decisions. This has given Mohawk ample opportunity to compete with well-established big brands. The graph below contrasts the difference between Mohawk's business model vs the traditional approach. AIMEE platform has significantly improved the life cycle of product launch and shortened the time from idea generation to product fulfillment.
Technical Chart
I like technical charts as a great starting point to screen stocks because charts are the real-time visualization of market psychology. Unlike 10-Q and 10-K forms that look at a company from the rear mirror, charts are always forward looking and tell a lot more about the future.
MWK had a big breakout with its record weekly volume in April 2020 - the market starts to show lots of interest in this stock and the stock has begun its upward trend since the breakout. The price trend follows 11-week moving average pretty closely, which serves as a support level. Every stock has its own main trend line to follow (the implicit line exists because it is also the indicator that big money players look at to decide their buying point). Any price action that deviates too far away from the main trend will eventually be pulled back closer to it. The current position provides a favorable risk/reward profile and a low-risk entry point. The price is right around the main trend line with a tight weekly price range and a light volume.
Bonus section about chartists
I didn't appreciate charts as much until many trading books I recently read helped me understand how much chart can actually reveal. However, many books have covered a lot about HOW to use charts correctly, but very few of them have explained the theories behind WHY charts are useful. The following section is not related to MWK specifically but more of my own thoughts I want to write down to reconcile what I've learnt lately. Feel free to skip this part if you are here for MWK.
Charts have two main components: volume and price. Trading volume essentially measures the amount of disagreement on the price of a stock. People sell because they think a stock is overpriced while people buy because they think a stock is underpriced. When there is disagreement on the price, there is transaction. When there is a lot of disagreement, there will be a lot of transaction and hence a large trading volume. In contrast, when the market has lots of consensus on what the price should be (think bond market), fewer people transact and the market reaches equilibrium, which is always accompanied with a lower trading volume.
On the other hand, stock prices are always determined by the most optimistic buyers who are willing to pay the highest on the market - a stock, therefore, is more likely to be overpriced when the trading volume is high and when the crowd is enthusiastic. When I say overpriced here, it's only short-term price action - it means buying at a high volume is likely to experience higher volatility and correction/consolidation after the market calms down.
Theoretically, if the stock has strong fundamentals, given long enough holding period, buying at high volume is not a problem because any price correction will eventually come back up in long run to catch up with its fundamentals. However, practically, this price correction always goes against human nature and is proven to be a problem for many people who failed to make the biggest profits from stock market. Many people lose money in stock market not because they didn't find the right stocks to buy; most of the time, they failed because they didn't hold the stock long enough until they make money.
Although the correction for stocks with strong fundamentals is believed to be temporary, nobody can really predict how much the correction will be - it can be as little as 5% or as much as 30%, easily. The most common reason to sell too early is the emotional pain one has to endure with extended period of paper loss. Psychologically, it's always painful to watch the price of a stock to drop right after your purchase. To reduce the chance of paper loss, starting a position when the volume is low and bar is tight, will greatly strengthen your conviction to hold a stock for long enough until you make profits from it.
Fundamentals
Charts can only tell so much about whether a long-term price trend has been developed and when is a low-risk entry point. The price advancement will only sustain if the company itself continues to grow its revenue and earnings.
First, MWK has very rapid revenue growth - in the recent quarterly announcement, the revenue growth has accelerated from 43.6% in Q1 to 97% in Q2 from continued eCommerce tailwind. The company expected its net revenue in full year 2020 to be between $170 million to $180 million. That's an easy 49% increase compared to reported revenue $114 million in the prior year 2019. The analysts' estimate for MWK's revenue in 2021 is $214 million, which represents only 22.2% growth rate. This number seems underestimated given how early stage MWK is at in terms of the company's life cycle. It's not necessarily a bad thing to have an easier forecast target to beat, because it is always the surprise of beating/missing the expectation that moves the stock price. MWK still has so many levers to pull to further grow its business, such as launching more products in its main US market, expanding to international markets and monetizing its AI platform. The following presentation slide lists 5 different opportunities they have identified to drive their future growth; many of them are just starting, far from maturity.
Second, I'm very encouraged by its textbook example of economies of scale. MWK is not a profitable company yet, but in the recent quarter it has reported its first quarter with positive EBITDA. I took a closer look at its recent income statement - the fixed cost has barely grown from $27 million to $29 million when the revenue has almost doubled from $30 million to $59.8 million.
This operating leverage will create a moat for MWK's business. As the revenue continues to grow, the percentage of operating expense in the total sales will become smaller and smaller, which will lead to eventual profitability. A company's stock price is ultimately determined by how much profit it earns. Profits are simply a function of two factors, sales and profit margin. So many companies dream to grow their earnings by growing their revenues or expanding their profit margins, but MWK seems to have both of them.
Insider holdings
Last but not least, I like to check the ownership of the management team to see whether their interest is aligned with all the other shareholders. It's reassuring to see the management team also has some skin in the game - when their personal net worth is directly tied to the stock performance of a company, they are more motivated to manage the company well and create values for the shareholders.
The table below shows the compensation the C-suite received in 2018 and 2019. Majority of the total compensation package came from option and stock awards. This is the compensation structure I generally prefer to see because the management team are not simply employees who are paid with a fixed salary. They own a share of the company they manage.
The details of the option awards also enhance my conviction in MWK. Most unvested option awards the management team holds have an expiration date in 2028 with an exercise price of $9.72. That's higher than the current price MWK is being traded at on the market. To prevent their option awards from expiring worthless, the management team has absolute incentives to increase the stock price to at least $9.72. This has provided enough margin of safety if the stocks are bought at current price level.
Conclusion
MWK has shown some very positive signs to be a multi-bagger super stock. I believe the company is still at a very early stage of its growth and it's currently at an inflection point to turn into a profitable business. With the presence of a relatively low risk entry point, I'm going to hold a sizable position until the investment pays off.
