A thought for today.

I feel an obligation, as I feel some responsibility for people on the board, to bring this to your attention.

I’m sure that you remember those moralistic guys who appeared when our stocks were down during the last three or four months, and who told us that we had offended the Gods of Investing by investing in these “overvalued” and “overpriced” stocks, and that we were being punished by those Gods by a permanent repricing of our stocks, which from now on would never again rise to the levels seen in July. They quoted books written 20 or 30 years ago that “proved” that no one can beat the indexes over the long run, and we should stick with S&P ETF’s.

Well, here we are, six trading days into 2020. Six days! And guess what? My portfolio is up 12.3% in those six days, quite a bunch more than an average entire year’s gain for the S&P.

I’m now up 44.2% from the beginning of last year, well off my October bottom of up only 9.9%. I’m sure that many on the board are doing even better.

What’s the message here? I’m not saying that you shouldn’t pay any attention to what the critics of our investing style say. Any criticism should at least be evaluated. Just that you should remember how scared you felt at the bottom, and how it felt that our stocks were going to fall forever, and leave a little note to yourself (mental or physical), to remind yourself next time it happens that crashes like that do happen, and that you will feel scared the first several times, maybe very scared, but to not let the trolls scare you out of your high confidence positions barring some good reason to sell them.

Best to you all,

Saul

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I’m not saying that you shouldn’t pay any attention to what the critics of our investing style say. Any criticism should at least be evaluated.

I also meant to say (but forgot) that this won’t go on forever. You can’t expect our stocks to go up every day. There will be pullbacks. That’s just life.

Saul

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There is a certainty and that every critic who says derisively “this time it is different” and uses terminology such as market “darlings” or the like will not beat the market over any material time frame.

Another certainty, any stock that Gary Alexander calls a bargain (okay, there are a few exceptions, but those like Alteryx, are not “bargains”) ends up losing to the market the way we define it (not just beating the S&P.

I just ran a year to chart, and I have done these many times, randomly, using multiple time frames and EVERY time, the “cheap” lost, big time. This time as well, year to date, PSTG CLDR TLDN, and this is random as I had this chart pulled up from months ago for some reason, I just changed the date to year to date, those 6 out of the 9 not considered “cheap” easily beat these three clearly cheap stocks. Put ESTC in there and it is also trailing the leading 6…it won’t be a 100% correlation, but even during this short time frame I can say, “no, this time is not different” as the cheap, slower growing stocks, are losing as they almost always do, all the time.

This is not to say valuation does not matter. I did not put Zoom or DDOG in, but I would wager they would be within the mix of the top 6.

Year to date >13% return, so although it may all burn in flames sometime, why not enjoy it! Very nice start to the year. And no, it is not different this time, not at all. It is only when those nay sayers come out (and criticism is welcome of course when honest but not self-righteous) self-righteously and say “I told you” are things acting differently this time (for a few months anyways).

Tinker

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Saul, the one thing I notice is when looking at legacy winners is that what’s “expensive” keeps getting expanded To levels more and more extreme.

Examples: MSFT went public at 20X earnings while doubling revenue each year.

CSCO went public at a time they were more than doubling revenue each year at 6x revenues. In 1990.

Now we have Datadog that is a favorite because they are closest to profitability and growing slower than both of the above, yet its at 40X sales. Not earnings sales. And the examples above are examples of biggest winners of all time.

I understand the whole concept of these high growth companies will always appear expensive but we seem to be getting to points where they’re approaching prices you’d expect mature versions of them to be. Example DDOG like $250 million sales and $11 billion mkt cap and SPLK $2 billion sales $24 billion market cap.

How long will it take DDOG to reach $2 billion sales and will it trade at a higher multiple than SPLK? They are a long way from $2 billion sales.

This is not limited to SaaS. If it were that obvious and only limited to software it would be easy. But for example PODD which is an insulin pump manufacturer is at 26x sales growing at 40% revenues.

The point is the market seems to be willing to pay more for growth these days. So it becomes harder and harder to say “you lose money by worrying about paying too much” because the market is assuming terminal growth rates and size from the day of the IPO. What I’m saying is the market seems to be more efficient about not underpaying for growers companies. Price does not matter? CRWD and ZM are not doing that well for those who bought after the IPO. And those were some of the higher priced IPOs. We’re talking market caps higher than the vast majority of the y2k survivors out there.

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CSCO went public at $224 million market cap February 1990 $27 million sales in 1989. $69 million sales 1990. Nothing like that is happening now. It’s more like a couple billion for that kind of growth on day one.

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This thread is really interesting

The analysis that is distilled from the wisdom on these boards is both quantitative and qualitative. The key outcome is deciding what companies have a sufficiently high CAP to be worth the premium. This is essential in deciding WHAT to buy. But there is a point where the price premium stacks the odds against you, leading an investor vulnerable to a hint of negative information or assumptions - the challenge of being priced to perfection.

I’m in the camp that valuation does indeed matter, and where is matters is in deciding when to make a purchase, not what to buy. It does NOT tell you what to buy.

It’s useful to run the numbers and to have a sense of relative valuations, but there is much value in understanding the more qualitative factors such as ease of onboarding DDOG vs ESTC for APM purposes.

The challenge is that the “secret of SaaS” is no longer a secret, so growth in stock prices due to multiple expansion is harder to come by. CAP, market cap to opportunity, tailwinds, revenue growth and promise of profitability become the main drivers for appreciation of stock prices.

The best companies that have eliminated/dramatically reduced uncertainty about product/market fit, CAP, TAM, scalability etc are generally expensive, understood. Why would they be cheap?

But if you bought PD, ESTC, ZM, ZS, CRWD in July, believing that price didn’t matter, it’s been a tough few months. Bar PD, I think that the story behind these companies remains compelling, and that the Sep-Jan 1 valuations were finally at a level that made it much easier to see the path for stock price appreciation. Once you have a year of perfect execution priced in, it’s harder to make the case in the next 12 months.Over the longer term, it’s less of an issue imho.

The difference over the last 6 months, from my perspective is that the high rates of growth, beat and raises from ER expectations in combination with with decreasing stock prices compound to dramatically compress the EV/S on a current year/2020 year basis, and making the investment case far more compelling for new money.

For previously established investments, valuation is typically not a good reason to sell (2019 $SHOP), but it might make me cautious of going all in at a 52 week high on an otherwise compelling investment. Dollar cost averaging in, sure
(as a volatility is guaranteed with these companies)

One final point - I understand that technical analysis is not part of the conversation on this board, but as a secondary or tertiary tool for decision making, it can add value in my humble opinion.

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CSCO went public at $224 million market cap February 1990 $27 million sales in 1989. $69 million sales 1990.

Example DDOG like $250 million sales and $11 billion mkt cap and SPLK $2 billion sales $24 billion market cap.

Nice Posts 12x, but I would suspect that if you account for profit margins, the huge differences you point out will not quite seem as large…

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olitalia, Cisco’s net income, NET INCOME was $14 million in 1990. I understand there is a difference in profit margins, ie TWLO has a lower profit margin than most SaaS companies, but it does not explain away the fact that the market is clearly paying more for growth these days, compared to the 1990s. If you read old stuff like I do, you’ll see that profit margins do not explain away the difference what growth companies trade for now vs. 20+ years ago.

Here is Mcafee’s 10k from 1996.
http://getfilings.com/o0000891618-97-001456.html

If you go over it, and look at the impressive stats, revenue growth 101% YOY to $181 million, actually profitable, you would likely be surprised that this company was trading at roughly 8x trailing sales in 1996. By the way, the company was profitable because it did not have to spend 50% of it’s sales on S&M expense like SaaS companies nowadays, but 28%. If the market is trading DDOG at 40x sales because of it’s operating leverage but not even profitable, you could imagine what it would be trading MCAF at these days.

I realize this is all probably OT so I will just leave it at that, that I have an observation that growth companies trade at much higher price multiples than they did in the nineties and earlier. Technology companies also did not have to spend as much on S&M for the same growth and therefore were profitable. I don’t have any solution to the matter anyways, it is only an observation.

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the market is clearly paying more for growth these days, compared to the 1990s

Interest rates explain a lot of this, and a market change in interest rates will constrain and likely reverse some of the market price increases we now enjoy.

However, I am definitely on the Saul train in seeing a material difference between a company from time gone by compared to one with a moat secured recurring (subscription) revenue for a mission critical money saving business service, with 70%+ margins, and a net retention rate (a newly familiar term) exceeding 100%, a mathematical impossibility so used to express successful cross selling to an existing client camped out and fully deployed on our side of the moat.

I suspect/hope many of these companies will cycle as MSFT did 2000-2020, from massive PE’s to conventional levels, and possibly then reaccelerating to better market penetration, better products and services and dividends. Even though the price never rose for years, the company became better and better, the proverbial comes spring. Many posters discuss the S curve and the supposed position of this company or that on the curve. My surmise is that all long term successful companies in our corner of the universe will need to swallow their excessive valuations at some point as growth slows due to competition, the weight of large numbers the effects of TAM penetration.

For many here, if these current favorites begin to resemble the tortoise more than the hare, they will likely continue to hunt for rabbits.

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CSCO went public at a time they were more than doubling revenue each year at 6x revenues. In 1990.

Crowdstrike, DataDog and Zoom went public at a time when they were roughly doubling sales. Let’s imagine Cisco was even more impressive than these companies and went public at today’s valuation norms. Let’s say 10x the valuation, selling for 60x sales.

$1k invested in Cisco at the IPO is worth $692,730 today, as long as you reinvested dividends, according to this article: https://www.investopedia.com/articles/markets/113015/if-you-…

So if Cisco went public at 10x the valuation, you would have 1/10 the return today. Only 69,273 for every $1000 invested. That’s a smidge over 15% annualized return over thirty years.

Not. Bad.

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I might have a slightly different opinion on our SAAS stocks and their valuations.

In the beginning, I think the market didn’t understand SAAS stocks, and their ability to grow revenue on low capital expenditure at very high rates for a very long time. This is a new business and technology model, and most didn’t understand it.

As this revenue growth has become more and more clear, with SAAS companies able to grow over 50% yoy for a long time, and even when plateauing able to grow over 20% yoy, investors are willing to pay more for these type of companies - after all, the theoretical price of a stock should be the current value of all the cash the company generates, and these will generate much more cash over time compared to a traditional company.

As this has become clear, more and more investors are willing to pay more for these stocks. The cat is out of the bag now - a lot of investors see the huge growth of these stocks and pile on.

The danger is that the market always overshoots. I expect that our stocks will rise to P/S that is simply too high, because of sentiment. At that point it will overshoot low, before settling on rational P/S for these stocks.

I absolutely am not of the opinion that our stocks are in a bubble or the valuation is ridiculous. I just think the market will naturally overshoot up, then down, until it determines fair value. I think that drops we will see in the future will be much much greater and longer than what we saw last year.

I am cautious for this reason - I’m keeping only about half of my portfolio in these stocks, and have lots of money in value and dividend stocks, as well as some hedges. I prefer to invest in SAAS companies that I see have models that are going to allow them to grow for a very long time - i.e. 20 years, but am willing to trade in and out of faster growers.

We have been smart and luck so far to invest in these stocks before the market realized what they were. Now that the market is getting it, I think the future will get more difficult. I still believe that SAAS stocks have an amazing business model which makes them excellent companies to invest in. I just don’t think they are the only model. Value investing, hedging, all has its place in my portfolio - I want the ability to buy SAAS when (what I see as) the inevitable drops come.

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Bubbles have a specific anatomy. I learned this during the bitcoin craze of 2017. You can see it here: https://www.variantperception.com/2017/09/22/the-anatomy-of-…

Bubbles start with a stealth phase, move into an awareness phase, and then go into a mania phase before crashing back down.

A couple of years ago, SAAS companies were pretty much off the radar. Now informed investors are aware of the opportunities. If there is going to be a bubble it feels as if we are in the awareness phase. It’s only during the mania phase that price starts to become totally detached from value. The peak of the mania phase happens when you overhear your taxi driver talking about it. In my case, during the bitcoin bubble, it started when my grade 7 students started talking about it, and peaked when I was seeing people on Facebook asking for loans to buy bitcoins. As an aside, I did have a student who learned about bitcoin in 2015 and bought some graphics cards to mine it. I had an experience of taking an hour to explain to this 12 year old how to manage the $400,000 he had made. He wasn’t able to concentrate in his classes because he was losing and gaining thousands of dollars every hour. Those were the days.

The only company that might be in a bubble is Shopify. I was reading comments in one article about overhearing people in the Toronto subway talking about how they are going to get rich by investing in Shopify. This is what to watch out for. I’ve done projections on Shopify and its hard to see how the current price is justified, given their growth, given their margins, and given their long term prospects. I’m sure the company is going to thrive for a long time, but this is probably not the time to move into a large position. It is probably better to scale into it slowly at this point if you want to own it.

Our stocks might enter into a mania driven bubble, or the valuations might simply ebb and flow over time. But I think its fair to say that companies like DDOG, AYX, ZM, CRWD, etc are definitely not in a bubble.

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I’ve recently made a habit of reading every post on a thread before I post a reply. I want to make sure that I have something positive to add rather than just repeating what’s already been said. The price of success is that this board has become somewhat unwieldy. I often ignore entire threads as I haven’t time to read everything.

I don’t know about you, but I have some personal truisms. For example, maybe 4 times out of 5 I find convenient parking spots. This defies logic. It’s like flipping a fair coin and having it reliable come up heads 4 times out 5. I can’t explain it. But I assure you it’s not just my imagination. My wife and daughter have both observed my uncanny ability to get good parking spots. Conversely, I can pick a line at Costco or the grocery store or almost anywhere and it will inevitably take longer to check out than if I had chosen a different line. The one I picked may have looked like the shortest, but somebody closer to the register will have picked up an item with no scan code on it, or there will be a problem with their payment method, or they’ll get in argument over an expired coupon, or you name it . . . My wife has commented on this as well. When I buy a new stock, maybe 75% of the time it will go down in price shortly after I buy it. These are truisms in my life. They’re not universal, you can’t draw any conclusions from it. It just is.

What I’m getting at is that some things happen no matter what you do. Sometimes, these inevitabilities are personal, some of them are more general. The vagaries of the stock market are inevitable, they are predictable in that we all know they will occur, but not very predictable with respect to when they will occur or how big they might be. It’s interesting in that there are many financial writers who make a living predicting what the market will do and when it will do it. Good lord! The yield curve is inverted - a recession will be upon us in six months - Oh, never mind, long term rates just went up so not to worry. I’ve not studied it in order to see if any of these folks actually have a consistent track record of being mostly correct, but I doubt it. It’s like mutual fund managers, most of whom can’t consistently beat the S&P index, yet they still have jobs.

I’ve argued that while many of our investments share some common characteristics, they can’t be referred to as a “sector” in any traditional sense of the word. Well, setting that aside, it can’t be denied that they swooned almost in unison at the end of July last year, they kind of bottomed after about 2 - 3 months but, IMO you couldn’t call it a turn around any time last year. Then, as if by magic, since the first of this year there’s been a surge.

This is a long winded introduction to my observations about valuation. Let’s start with the historical argument, which can be summarized with the observation that with time all investments revert to the mean, so it’s futile to even try to beat the average. Well, I’m not a financial historian but I’m willing to grant that the first part of this argument, reversion, is probably true. However, the second part is only true if you in fact hold everything you ever buy long enough for it to actually experience that dreaded reversion. And it also ignores that you may well make a bundle between then and now even if you do hold the investments indefinitely. But guess what, at least for my portfolio I no longer hold a single share of Skechers, Skyworks, or for that matter anything I held just a few years ago. So if you’re reasonably alert to the performance and changes in the landscape around your investments, this problem is not all that hard to avoid. Yeah, you might miss an obvious exit point once in a while (i.e., Nvidea, at least for me), but even though I am admittedly often slow to sell, I’ve not been stung all that badly. I’ve got results to prove it.

Let’s move on to a related argument, which is this time, just like every other time is not different. This is the bulwark of the arguments over valuation. These SaaS/cloud stocks are all in bubble territory, they’re all over-priced driven by momentum and none of them are worth the ratios they sport. Woe unto those who maintain positions in these frothy issues, you’re all doomed and bound for a painful fall. So let’s unpack that.

What’s a “bubble?” Seriously, that’s an important question. Is there a difference between a momentum stock and a stock that sports a high valuation or is it an equivalence? I don’t know what the magic EV/S might be that distinguishes a “fairly” priced equity versus a “bubble” priced one, but let’s arbitrarily say it’s about 15x. If you’re invested in companies below that number, you’re in safe territory, or at least not “bubble” territory. Above that number and you’re in danger. Again, I’m not a financial historian and there’s no way I’m going to spend hours let alone days analyzing that assessment, but I’m willing to gamble that there’s a grand total of zero statistical evidence to back that up, holding all other factors constant.

Mind you, I’m not arguing that there is no such thing as a bubble. Though I’m not a historian, I think almost every investor (and a lot of non-investors) are familiar with the tulip craze in the 1600s. By no means the only bubble, just one of the better known ones. The dot com mania is another of more recent memory.

How can you separate a bubble stock from a justifiably highly valued one? That question pretty much goes to the heart of the issue. When we experience a down turn and the naysayers flock to the board to issue their warnings (or “I told you so’s”) the underlying assumption is always that high valuation equals bubble. It has to be an a priori premise because without it, there’s no basis for the warning at all. I’m actually not going to waste a lot of your time describing the difference. Saul has repeatedly pointed out why these investments are not the same as bubble momentum plays and truly are a departure from the investments of the past - even the very recent past. In a nutshell: real products, real customers, real revenues, real margins. These companies are not strictly selling promises (although, all of them do sell some promises. Promises about new products, services and processes which they reliably tend to keep). Companies that sell mostly promises with little to back them up are prone to be bubble stocks (I make a caveat for biotechs which always sell promises until they field their promised products - this is the primary reason I avoid these investments, though I have done well with a few recommendations Bulwnkl has brought to the board).

We need to understand that high volatility and high risk are two separate phenomena. High valuation investments lend themselves to high volatility. There’s tons of evidence for that. But just like the macro phenomena I referenced earlier, when and how far the price swings might occur for a specific investment is not predictable. You can pretty well bank on the fact that it will happen, after that, all bets are off. This is one of the things I find somewhat amusing about so many SA articles that provide the advice that goes something like, “Great investment, but too highly valued, wait for a dip. When the price drops to $X make your move.” Good luck with that. They never once make an observation about the cost of a missed opportunity - never.

Recently on the board Saul and another member (Bear?) had a discussion about valuation. Saul more or less asserted that he ignores valuation in his investment decision making process (if I’m getting this mixed up or confused, please correct me). The other board member countered with something like if the EV/S ratio went to 100 you wouldn’t buy, therefore you are sensitive to valuation. Saul essentially replied that he was not going to be drawn into a reductio ad absurdum argument. Of course that’s a vaild observation, but it’s irrelevant with respect to our investments or our decisions about them. Our investments are priced based on market equilibrium that balances supply and demand. It is what it is because that’s what the market says it is. Will it be the same tomorrow or next week? Most likely not. Will it be higher or lower - your guess is as good as mine, let’s both concede it’s a guess. Will it be higher or lower in 6 to 12 months? From Saul’s point of view (mine too) if the answer to that question isn’t “yes” with a pretty high degree of confidence, the correct action is to sell rather than buy, or possibly do nothing depending upon other factors.

One more point and I’ll stop . . . I was surprised at my own reaction during last years contraction in our investments. I got somewhat panicky, at least at first. I had always known it was coming and I thought I was emotionally prepared for it, but when it happened, and then got worse, and then got worser I got very uncomfortable with the erosion of value in my portfolio.

But, to my credit, my action in the face of the deterioration was to do nothing. I didn’t sell, I didn’t trade in and out of my positions, I didn’t do anything. Somehow I found the fortitude to recognize that really nothing much other than price had changed. It was still the same companies, products, strategies, management, competitive threats, even performance, all those things were pretty much the same. So when I thought about selling, I also thought about what will I do with the proceeds? Just sit on the cash (and pay capital gains tax). Buy gold or bitcoin or blue chip or . . . I just couldn’t come up with any good alternatives, so I did nothing. I might add that at no time did my portfolio ever enter negative territory. Yeah, at the nadir it dropped back to where I was last February, but that wasn’t all that bad really. When I got serious about investing, which was about the same time I started following this board, I set the goal of 20% per year. I felt that was a stretch but achievable goal. My portfolio dropped to from up near 80% to up just a hair over 20%, but never went below that level. I closed 2019 at up 34%. As I type this post, I’m up 12% for the year (and I swear, my portfolio is not a copy of Saul’s).

I know, this is a long missive. I hope some of you find some value in it.

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Well, I’m not a financial historian but I’m willing to grant that the first part of this argument, reversion, is probably true.

As you point out, the key is that LTBH doesn’t have to mean forever. With any technology, one expects an S curve of adoption. In the middle of that curve things are changing rapidly and one can expect that small changes or even fake changes will alter the picture a lot short term, but as long as the basic story holds things are going to continue to grow rapidly. Whereas, when you get to the top end of that curve, everything slows down a lot and the future becomes much more predictable, so one necessarily expects less volatility and less growth and valuation rewards for growth. If one is looking for those valuation rewards, it is time to move on. Unless, of course, the company comes up with another product that starts another S curve.

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Curious to know which SAAS stocks you hold that fit into your long term 20 year basket?

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Sorry this question was aimed at SteppenWulf.

“Curious to know which SAAS stocks you hold that fit into your long term 20 year basket?”

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As this has become clear, more and more investors are willing to pay more for these stocks. The cat is out of the bag now - a lot of investors see the huge growth of these stocks and pile on.

The danger is that the market always overshoots. I expect that our stocks will rise to P/S that is simply too high, because of sentiment. At that point it will overshoot low, before settling on rational P/S for these stocks.

Steppenwulf… very astute observations… one sees momentum led temporary euphoria in the market all the times… few years back, it was 3D printing… two years back it was bit coins… and then Beyond meat etc… there is

However, most of these are one tie, short cycle because wider investment community recognizes short coming of these businesses and short sellers start piling up and then they go down strongly to undershoot for a long time before getting back to rational valuation…

If I may submit, I believe SAAS is special for all those reasons Saul and many point out in this board… I dont believe market has fully grasped SAAS business’ strength (and weaknesses)to the right extent and these business will continue to grow at amazing rate… so my personal belief is that SAAS valuation overshoot by July / Aug 2019 and subsequent undershoot is just first of multiple such cycles we will see… it is possible (but not necessary) that with each cycle we will see smaller peak and valley (smaller overshoot and undershoot) of valuations as market forces get better grasp of these businesses over a period of time…

To understand this better, think of how wild a ride each of big names of today - Apple or Amazon or Netflix have had in with massive overshoot and undershoot of valuation over a period of 20 years… this is because each of these companies delivered on phenomenon like SAAS… they kept delivering success after success… and with each undershoot in valuation, market was only handicapping only near term view of their business…

I believe our stocks collectively fall into similar bucket… I am not arguing that any of them can come closer to these names (one or more of them may or may not)… I am just saying appreciation of these business’ strength will not develop in one cycle like 3d printer stocks or bitcoins… SAAS is a stronger, longer term phenomenon… and now coupled security, big data, analytics and AI, it is even harder to grasp full potential of these businesses over 2 or 3 years timeframe…

We are already seeing ramp of some of these names in 2020… they may lose the tight correlation like last time… the extent of overshoot may be smaller (though not necessarily)… but I am confident that another overshoot of valuation of these stocks is coming… not giving up on market upside of these businesses yet.

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