Current Oomph factors and valuations

Investment Analysis Clubs Saul’s Investing Discussions
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Yesterday, draj asked if I have the current Oomph factors of the companies that are commonly held by many here. As a matter of fact, I do, and am presenting the results and valuations in this post. Some interesting conclusions are that I find Shopify to be reasonably valued all of a sudden, but Fastly’s valuation seems stretched. I also analyze how EVSO multiples have expanded from a year ago.

You can skip the next section if you already know what Oomph and EVSO are.

What is the Oomph factor?
The Oomph factor is a metric I devised last year to measure the financial performance of hypergrowth companies. I first presented it in this post: https://discussion.fool.com/the-oomph-factor-34182263.aspx To calculate the Oomph factor, take the square of the Quarter-over-Quarter (QoQ) revenue growth rate, written as a multiplier. Then multiply that by the company’s Gross Profit Margin (GPM). Note that QoQ means the latest quarter compared to the same quarter a year ago.


Oomph = GPM*(1 + %Sales Growth QoQ)^2

For example, if a company is growing revenues 50% QoQ, the multiplier is 1.5, and 1.5 squared is 2.25. If this company has a GPM of 60%, then the Oomph factor is 2.25*0.6 = 1.35. When I first posted about this, I noted that companies with an Oomph factor above 2.0 are doing exceptionally well. There are relatively few of them, and they’re hitting it out of the park.

The EVSO ratio is a valuation metric that measures the multiple of Oomph that investors are currently willing to pay for a company. It’s calculated by taking the EV/S ratio and dividing that by the Oomph factor. Just like P/E ratios, the lower the EVSO ratio, the better, from a valuation standpoint.

Current Oomph and EVSO Valuations
Here are the current valuations of the companies I hold, plus a few more, based on the above metrics. It’s sorted by ascending EVSO.


**Gross   Revenue**
**Ticker  Margin	Growth	EV/S	Oomph	EVSO**
ZM	61.0%	169.0%	56.3	4.41	12.7 <--- most undervalued
CRWD	78.0%	85.0%	34.3	2.67	12.9 
LVGO	74.4%	115.0%	45.2	3.44	13.2
MDB	71.0%	46.0%	22.3	1.51	14.8
AYX	88.0%	43.0%	26.6	1.80	14.8
DDOG	77.4%	87.0%	53.6	2.71	19.8
NET	78.3%	48.0%	34.7	1.72	20.2
TWLO	52.9%	57.0%	26.6	1.30	20.4
SHOP	52.5%	97.0%	43.5	2.04	21.3
OKTA	77.2%	46.0%	37.6	1.65	22.9
TTD	78.1%	33.0%	32.3	1.38	23.4
ZS	77.7%	40.0%	38.3	1.52	25.2
COUP	72.3%	49.0%	43.1	1.61	26.9
FSLY	57.6%	38.0%	39.5	1.10	36.0 <-- most overvalued

Based on the above, Zoom is the most undervalued of the lot, even with an EV/S ratio of 56! That’s because it has an Oomph factor above 4.0, which is an extraordinarily high level. Other exceptional companies with an Oomph factor above 2.0 are CRWD, DDOG, LVGO and SHOP.

The EVSO valuation ratios are clustered in 3 different ranges. There’s the lower-valuation 13 to 15 range where ZM, CRWD, LVGO, MDB and AYX reside. Then there’s a jump to a mid-level valuation range of 20 to 23 where TWLO, NET, SHOP, OKTA and TTD reside. And, finally, there’s a highly valued range above 25, with ZS, COUP and FSLY.

Fastly, with an EVSO of 36, seems like an outlier. I know they raised guidance for the quarter and year, but even then, I don’t know why the market is valuing them this high.

Based on their latest blowout earnings call, Shopify’s EVSO ratio has come back down to earth, at a “reasonable” value of 21. If it gets back to its historical valuations, I wouldn’t be surprised if the stock moves significantly higher from here.

Speaking of historical valuations, how much have EVSO multiples expanded compared to a year ago?

Comparing EVSO Ratios to Last Year
The following table compares today’s EVSO ratios to last year (specifically, to April 2019).


         Cur.  2019
Ticker   EVSO  EVSO  %Change
AYX      14.8   9.4   57%  
ZS       25.2  15.1   67%
MDB      14.8  13.4   10%  
TTD.     23.4   9.7  141%
TWLO.    20.4  14.1   45%
OKTA     22.9. 15.9   44%

MDB is remarkable in that its valuation multiple has stayed pretty much the same, despite the stock going up 62% since April last year. All the others have experienced EVSO multiple expansions of 44% or higher.

Conclusions
Based on the above analysis, I’m inclined to put new money into Zoom, CRWD, MDB, and SHOP, and avoid putting new money into FSLY for now. Please note that EVSO is just one way of evaluating a company, and there’s nothing magical about it, nor is there enough data about its predictive value. Saul came up with an improvement to the Oomph factor in message #55380 which you should read. You should also read Saul’s knowledge board about other factors in evaluating companies, like founder-led, Total Addressable Market, Net Dollar Expansion Rates, etc.

I hope this post has been useful.

-Ron

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I hope this post has been useful.

Yes it has Ron. Thank you.

If my may ask…
My gross margin results differ from yours on some stocks.

Looking at DDOG you have the Gross Margin at 77.4%

I got the Gross Margin from their Q120 results (pasted below) as 80% for both GAAP and non-GAAP.

https://investors.datadoghq.com/news-releases/news-release-d…

Did you compute the Gross Margin differently from what’s shown on their report?

Thank you for the great post. Rob

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Looking at DDOG you have the Gross Margin at 77.4%. I got the Gross Margin from their Q120 results (pasted below) as 80% for both GAAP and non-GAAP.

Rob, you are correct, the gross margin for DDOG should be 79.8% and not 77.4%. It was a copy/paste error on my part.

The Oomph factor doesn’t change much, it goes up to 2.79 from 2.71, and the EVSO goes to 19.2 from 19.8.

Thanks for pointing this out. To calculate these numbers, I always go the latest earnings release announcement at each company’s investor relations Web page.

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Hi Ron,

this has been very useful as a rule of thumb, thank you so much for the update. I’m usually too lazy to keep these tables updated myself so I really appreciate you putting in the time. It’s good to know that there are no crazy outliers on the list.

However, I feel that these valuation tables can be quite misleading. For example, taking reported (past) numbers for growth skews the results. The market is always forward-looking and doesn’t price stocks based on past results but the expectation of the future. The best example in your list is Fastly. They come out as most overvalued because you have them at 38% growth (from last quarter). But next quarter they will probably grow more than 60%. That’s a huge difference and would put them (assuming 60% growth) at an OOMPH of 1.47 and EVSO of 26.8. Now, you could still say that that’s rather expensive on the list but puts it more in line with the rest and maybe even suggests that assuming 60% growth is too pessimistic.

But even using next quarter’s growth rate creates problems here. Take Zoom: They are by far the “most undervalued” in your list but guess what if you did not take the growth rate of last quarter (+169%) but guidance for next quarter (+242%): OOMPH of 7.13 and EVSO of 7.9! BUY BUY BUY, right?

It cannot be that easy in my opinion and it usually isn’t…

How to alleviate that problem? Maybe using longer-term future growth rates, like the average 3-year-growth rate that Bert Hochfeld predicts and uses. But there you could also question one’s ability to predict a growth rate so far out with any accuracy. That’s the nice thing about using reported numbers: You know them for sure.

I would generally suggest changing the thinking around valuation metrics. We should not look at the list and say: “This is an opportunity, I will buy that” or “that’s expensive and should be avoided” but to take this as the starting point of analysis. Why has the market given the company this valuation? Does it make sense? Is it too euphoric or too pessimistic? How can I find evidence for that?

This is of course very hard but you can watch Saul and others do it again and again on this board with great success. Also, it makes sense to “trust” the market to a certain extent both on continued up moves (quick signal to buy) and down moves (quick signal to sell). What I have found again and again in the past is that the market is very good at anticipating future results, much better than any individual. I just experienced that with Shopify. I thought they were overvalued around $628 a share when they pulled guidance and I saw reports of some Shopify merchants struggling. Thankfully, I didn’t trim because I was suspicious that the market may know more than me. Next thing you know is they go up to over $1,000 before earnings and report a complete blowout with the stock barely reacting – the market already knew…

If you are thinking about what to buy next I would suggest the following instead of looking at EV/S ratios and the like:
1.) What is my confidence level in the stocks I consider buying? (i.e. look at fundamentals not price)
2.) What is my current portfolio allocation and does it reflect my confidence level?

Then you buy the highest confidence level stocks where you think there is still room to allocate more % in your portfolio.

Best
Niki

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I would generally suggest changing the thinking around valuation metrics. We should not look at the list and say: “This is an opportunity, I will buy that” or “that’s expensive and should be avoided” but to take this as the starting point of analysis. Why has the market given the company this valuation? Does it make sense? Is it too euphoric or too pessimistic? How can I find evidence for that?

The problem with deciding on stocks based on valuation is that your investment thesis is then that the market will value it higher in the future. This takes into account various algorithms, sentiment, technical factors, micro- and macroeconomics, global sentiment, etc. It’s hard enough to determine why a company is valued at any one point, you also have to predict the future for all those factors.

If you invest on growth metrics, you just have to decide whether the company will continue growing. Valuation may rise or fall but you trust that assuming the overall narrative is unchanged, valuation will stay relatively similar and the price will rise with growth. Making investment decisions based on valuation is more like very slow day trading where you’re just counting on volatility in valuation (in my opinion, very difficult to predict) rather than actual performance.

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Hey, wait. “Probably 60%” is just guesswork. Ron is dealing with the only actual, direct facts known to anyone about Fastly.

The part that makes this board “special” is the ability to remain focused company growth, not the stock returns growth. Companies report every 90 days, and that’s why they/we work from the facts and until the facts signal otherwise, the reported growth is assumed to continue forward.

Not commenting on the portfolio management, because that’s not what we do, here.

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**Gross   Revenue**
**Ticker  Margin	Growth	EV/S	Oomph	EVSO** 

FSLY	57.6%	38.0%	39.5	1.10	36.0 <-- most overvalued

Yet today FSLY is up over 12%.

This is the reason I gave up on crunching more than the very basic numbers. If economics were like physics it would work but physics does not have rational or irrational behavior most of the time.

Over time I have been shifting from number crunching to chart comparisons. Not traditional charting indicators and double talk, just looking at the pictures, for example, here I’m comparing FSLY (the blue line) against two of my high conviction stocks, ZM and TDOC:

https://softwaretimes.com/pics/fsly-08-03-2020.gif

This captures the market’s mood at a glance. Next you need to figure out why. My best guess with Fastly is that Mr. Market is looking at the Edge product that is coming online and there is no way to capture that by looking at historic data.

Denny Schlesinger
long FSLY

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Note that QoQ means the latest quarter compared to the same quarter a year ago.

Is that because you’re assuming these businesses are yearly cyclical, or something else.

One thing to keep in mind is that a company like Fastly has only been public for a little over a year. I think it’s really hard to compare investments in FSLY and SHOP due to the relative size and history of the two companies.

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This captures the market’s mood at a glance. Next you need to figure out why. My best guess with Fastly is that Mr. Market is looking at the Edge product that is coming online and there is no way to capture that by looking at historic data.

IMHO this is exactly right. But “the market” aka “those making large bets” is reacting not just to the edge product alone. First the beta testers have been growing more enthusiastic about the product and its potential. Many are developing uses cases already. The judgement is being made that this will be wildly successful.

Second the public endorsement of FSLY product by SHOP is not only significant in itself but also a clear indication IMHO that there is or soon will be general acceptance of the superiority of FSLY edge computing structure and performance. The market sees that as a large, possibly near term, payoff.

Other things like Fastly’s 35microsec latency, and recently announced enhancements of developer capabilities add to the mix. Given the rapid growth of WFH and increased usages which depend on low latency investors are concluding that FSLY is winning big.

Incidentally NET just announced a zero latency response for certain conditions. The recent article by SSI explains why that isn’t as remarkable as it sounds.

To return to OOMPH. Last year Saul defined a modified OOMPH factor which incorporated % recurring revenue. As soon as I get some time I hope to check out how that changes things.

Perhaps the most useful aspect of a measure like this is to stimulate thinking about why there may appear to be logical discrepancies in the results. My view is it could be that some very knowledgeable people with $$$ have detected something that the rest of us have not.

Cheers

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A little correction:

“Note that QoQ means the latest quarter compared to the same quarter a year ago.”

That is YoY (this quarter over the same quarter a year ago, also not to be confused with TTM). QoQ generally compares this quarter to the last one.

I agree with everything Nikki said. I am sure going through this exercise, as well as the serious time it took to put this post together, was helpful. Seeing the data is always helpful as well. I just don’t think it should be taken as predictive, and it sounds like that is what was attempted…?

rtichy said:

" Hey, wait. “Probably 60%” is just guesswork. Ron is dealing with the only actual, direct facts known to anyone about Fastly.

The part that makes this board “special” is the ability to remain focused company growth, not the stock returns growth. Companies report every 90 days, and that’s why they/we work from the facts and until the facts signal otherwise, the reported growth is assumed to continue forward."

(I must have missed the part about the stock price discussion. Commenting on the other aspects…)

I disagree. Many companies also provide Guidance. Then there is news, new customers, new acquisitions, fluid dynamics unique to each company. All of these aspects help me make educated guesses about the future and build conviction. After all, “Past performance is no guarantee of future results”. Taking only the past numbers without the context of all the rest is like putting blinders on.

After reading the original post, I was going to suggest that adding the next quarter or two in to the model would actually create even more discussion and provide a better picture of conviction. After all we can’t argue with the reported numbers, but we can discuss our interpretation of those, and any guidance, through the lens of the business and expectations, and how we believe they will be projected in to the near future.

Someone already brought up Fastly’s next quarter being potentially 60% or more, which is something I just posted about earlier tonight. I was going to use that example myself. If you also believe this, why not plug that in and see how the model changes. If you don’t believe it will be that high, then I’d like to hear why. Even if you agree or think it will be higher, I’d also like to hear why.

Zoom was also brought up. We have guidance there, by the company, of an end-of-FY revenue at $1.8B. If you treat that as below-the-low-end, as it should be, then some educated guesses are quite possible (I posted projections on just this not too long ago).

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