Invest in the winners

Investment Analysis Clubs Saul’s Investing Discussions
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There are companies that have been growing and there are companies about which we can say they seem to be completely dominating their market(s) on which they focus. Tinker has been beating the drum on avoiding companies that are cheap and that it’s ok to invest in companies that are expensive but are clear winners. When I think about my portfolio and which companies to buy, which to keep, and which to sell, I try to look through the lens of investing and allocating more funds to the clear winners. Sometimes it seems obvious that a company is winning, but sometimes a company can be growing very fast yet it’s not completely clear to me whether they are currently winning and whether they are likely to keep winning. Let’s have a look at some companies:

AYX: It is my largest holding at 34.9% allocation. This allocation has grown without adding any new shares (or call options) since early November. In my opinion, they are clearly winning in their market. To me all signs point in the same direction: 1) management commentary (not seeing any competition), 2) financial metrics (growth, growth acceleration, margins, customer growth, land and expand (DNE), G2K customer growth all point to no resistance from competitors), and 3) assessment of the market dynamics should no signs of any competitors. Add a huge untapped TAM that is expanding then you have a recipe for much growth and success ahead.

CRWD: It is my second largest holding at 15.3% allocation. My confidence is not as high as it is with AYX because there are competitors. However, I added to my CRWD significantly in December. The financial metrics (growth, customer acquisition, progress to profitability, and the seemingly effortless ability to sell and cross-sell to customers are outstanding) point to a product/solution that is being adopted very rapidly and with little resistance. One can contrast this with ZS which is struggling to add customers due to the competition and top down (all or none) selling approach. This tells me that CRWD is currently winning. Since it is a competitive space with multiple competitors, we need to monitor the situation closely for signs that the winning continues or slows.

MDB: It is my third largest holding at 10.1% allocation. The metrics have been great yet in the past few quarters they have deteriorated somewhat and there are signs that growth may be slowing. Yet, it seems to be a clear winner in the no-SQL DB market…not the only winner but a clear winner. A winner is a massive, rapidly growing market. I think it’s safe to say that the market will keep growing and it will be massive. Therefore, MDB should be around to reap the benefits. I plan on stocking with it even if growth slows significantly in 2020.

OKTA: It is my fourth largest position at 8.6% allocation. It is the clear winner in their market (zero trust sign-in). Growth is a bit slower than some of the other positions that I hold but their clear winner status keeps me invested in it.

So the above companies are those that I don’t see myself selling out of in the near future. The following companies are lower confidence positions as their winning dominance is either not currently completely clear or, in my opinion, I’m not sure whether they will be able to maintain dominance.

TTD: It is my fifth largest holding at 6.5% allocation. Growth has been inconsistent, sometimes really good and other times slower. They are the winning company in programmatic advertising. That market is not huge yet but it should grow. Can others in the future do what TTD currently dominates? I don’t know if they will be successful. How fast will programmatic advertising grow? I’m not sure. So to me their winner status is not as clear as it is for AYX or MDB or OKTA.

SMAR: It is my sixth largest position at 5% allocation. From the beginning I’ve been in SMAR for the financial metrics. I’ve been telling myself that I keep in it as long as the growth is there. Do they completely dominate their market. I don’t really know. But it seems to me that they might be replaceable. But for now they are having great success in acquiring new customers and their growth has been consistent. So every quarter I check the financial and decide whether I want to keep my position.

ZM: ZM is my seventh largest position at 4.2%. Growth and profitability progress are amazingly high which demonstrates that they are efficiently taking share from competitors. Yes, there are competitors but customers are moving away from Cisco’s WebEx and to Zoom. This is a good situation but not as good as AYX rapidly expanding in a greenfield opportunity. This is because I can look at AYX and say it is likely that the situation will be the same in 3 years. With ZM it’s not clear to me. For how long will the rapid growth continue? I don’t know, but I intend to stay in it while the growth is so great.

GH: It is my eighth largest position at 3.6%. I just bought it last week so it’s a new position for me. It is completely different that my other holdings. Different industry with high regulation and monopoly (for a time) situation due to intellectual property protection. I’m in it for the growth, the untapped disruption of a huge market, but I realize that failure to get FDA approval in the coming months can make this one a dog. It’s a risk-reward bet but I’m not going to make it a huge position with the FDA decision coming.

DDOG: It’s my ninth largest position at 3.3% allocation. Of course, the financial metrics are amazing and this demonstrates that they are winning. But they are not the only dominant player like AYX and OKTA, and I am not confident that they will keep winning for an extended period as we have seen that customer preferences can change quickly in their target markets. Also, when I ran the rosiest of rosy 5 year projections with a likely value after 5 years, I came up with a 15% CAGR assuming a $40 per share starting price. Thus, DDOG is expensive even for the best possible growth. For these reasons, I am keeping DDOG a small position.

ROKU: It’s my smallest position at 1.3%. It’s really a starter position. They are competing with Amazon. I don’t have visibility on how the competitive landscape will play out.

So along with great financial metrics, I greatly weigh my view of market dominance when choosing my positions and when determining how much to allocate to each.

There are other companies that we can look to (companies that I do not currently own).

TWLO: They seem to me to be dominating their market. They will be around as a dominant company for many years. They seem like a clear winner. But with TWLO I’m not sure that the shares will appreciate as rapidly because they massively diluted themselves with the slower growing SendGrid acquisition. Also, their CEO’s misleading statements about growth has disqualified them as a holding of mine.

SHOP: They are another clear winner. They are completely dominant as the place for merchants to run their online stores. They company will continue to grow and get bigger and bigger. I’m just not sure how much opportunity there is for the shares to increase as they are very highly valued…

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Chris, I wrote a message on here a while back about companies like ZS, MDB, and a few others being a leader in their space, someone responded by saying “they are not leaders in their space, they are just in favor because they are small and growing fast.”

I think there is absolutely a huge difference between buying leaders in their space, and just buying small companies only because they are growing fast. Buying small companies only because they are growing fast, in my opinion, is a recipe for disaster. It’s enticing to get in on the ground floor of some small company and hold it as it just zooms past it’s larger, more established, better financed, higher resourced competitors. History shows the odds are against the upstart. UNLESS the upstart is doing something fundamentally different. In the case of Nucor, they were able to undercut US Steel, Bethlehem Steel, and the rest, because of their new design “mini mills” situated across the country that were able to offer lower cost steel using recycled materials. So while they were a smaller competitor, they were doing something fundamentally different, something the larger competitors could not do or compete with.

I will give you another example. Microsemi has a huge hold on the military grade and space level diode and transistor market. They have a huge product portfolio of Defense Logistics Agency certified components. If you want to sell these types of products, you have to certify them with the DLA. OnSemi, Fairchild, and several others have tried entering this market over the years, because it is a very lucrative market and Microsemi literally controls it. There are others such as Semtech and Sensitron, but none match the scale of Microsemi. Every time a new competitor enters the space, Microsemi lowers the cost on that product line so that the new competitor loses money, until they finally leave the space. They retreat because they offer no differentiated product or a superior, cheaper way of doing things. They are just a smaller version of the larger, better equipped, better financed, etc., big player. If OnSemi were an upstart at the time they were trying this, one could easily get excited they sold $100 million vs. $25 million the year before, and bid up the shares like crazy, and be bored with Microsemi’s growth from $2 billion to $2.2 billion YOY. But it just doesn’t work that way.

Which comes to CrowdStrike. To me, Crowdstrike is not just a miniature version of Symantec. CrowdStrike leverages their cloud based technology to offer a superior product that Symantec and the rest are just trying to band aid to compete with this new upstart. But the argument is, CrowdStrike is the Nucor of this generation. They are doing something superior when the incumbents are so invested in their old way of doing things they cannot compete.

ZS is also doing something unique and different, but it appears the incumbents are pulling all their resources to provide a “good enough” solution to slow adaption of the new cloud based network security model.

I invest in CrowdStrike because I can see the difference between their competitors. I do not own DataDog because I cannot tell the difference. Not to say they are not different, I just do not know how nor do I understand the competitive landscape.

But every single one of the companies in my portfolio are doing something “new.” Some of them just happen to be in old industries.

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What an amazing Market…from discouraging loss yesterday…to winners, today!

Especially good news is Saul’s AYX…UP OVER $3.again! Glad I bought it, this month.

SQ is continuing up, too. Wonder why…Past time to check. Bought the stock when the Company went public…had been impressed by the service.

OKTA is another longtime holding of mine. Glad you like, OKTA, Gaucho. STJ

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Seems like MA/V should be on this list also.

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12x,
This can easily become a pedantic discussion so I won’t drag it out. But IMO whoever asserted with respect to MDB and ZS “they are not leaders in their space, they are just in favor because they are small and growing fast.” is simply wrong.

Both these companies (and most of the others we frequently discuss in this space) are indeed doing something special, they are leaders in their space and they have significant moats usually comprised of IP protection and mindshare. I’ve noted on at least a couple of occasions that I’ve witnessed a very similar situation in the DBMS space, first with IBM’s hierarchical DBMS, IMS which was subsequently displaced by Oracle’s RDBMS. MDB is clearly the winner in the document DBMS arena. Yes, there are a bunch of also rans - this was true for Oracle and to a lesser extent IMS. Saul is frustrated with MDB’s performance numbers so he bailed on the stock. I too am frustrated by performance, but I have enormous confidence in the technology. I reduced my position by about 50% as I am confident that Mongo will continue to grow for years to come. They may displaced at some point when an entirely new data model comes to fruition, but I am quite certain that that is many years in the future. It’s always true that bad management can kill the most promising company, I don’t believe Mongo’s management is that bad. Without a lot of discussion, I will assert the same is true for ZS. Simply put, whoever that “someone” is, clearly does not understand the space that these companies are operating in.

One more point.I found your discussion of Nucor and Microsemi interesting, but irrelevant. Steel is a commodity. As is always the case with commodities, price is the main competitive factor. It just isn’t part of the discussion. Microsemi is a little different, but not much. A semiconductor is plug and play. There’s no human interaction with the device, either in it’s application nor in it’s installed operation. Humans don’t get “inside” it, and it only interacts with other electronic components. It is more or less the definition of a “black box”. It provides whatever its functional design predetermined it to be. End of story. This is very different from software. This is true for middleware (i.e., MDB, ESTC, etc.) as well as applications (DDOG, AYX, etc.). Interestingly, cyber security software kind of dances between middleware and an application, but it’s more similar to middleware.

The point is, and it has been made more than once on this board, the convergence of cloud, internet, IOT and other emergent data/information technologies has created a new paradigm. Comparisons between industrial age technologies and information age technologies are prone to be full of pitfalls.

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I’d mention TDOC as it’s nearly doubled in the past 6 months. It seems to be sustainable and without much competition. Not sure how much higher it can go, or if it has peaked and will start to level out, but it’s one of my favorites to watch!