A uniting principle

Investment Analysis Clubs Saul’s Investing Discussions
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In looking at the list of my companies, the uniting principle is that each is a leader in an incredibly rapidly growing new market that has been created by the Internet, the Cloud, ecommerce, the explosion of Big Data, Artificial Intelligence etc. They are totally different than the choices people had to invest in a generation or two ago, which were, for example, a chain of stores or of restaurants, a slow growing chemical company, General Motors, General Electric, the telephone company, a furniture maker, a clothing company, Kodak, a office equipment manufacturer or office supply company, a hospital chain, etc. Companies like those are still out there and probably make up a lot of the Dow and S&P, and make up a lot of the stocks that a financial advisor would be compelled to recommend to you, but we are investing in a different world.

There are still people who are anchored in the old world where suitable companies should be growing revenue at 5% or 10%… and 20% growth would be fantastic! They think we should be satisfied with an 8% total return from the S&P, and they are sure that our investing in companies growing at 56% must be terribly risky! Then they are appalled and frustrated when our “terribly risky” portfolios don’t crash and burn, but keep rising instead, but as I said above, we are investing in a different world.

Just my way of looking at it,

Saul

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Agree, well worded.

Another thing we have to look out for is rapid changes, including to today’s growers. The rate of innovation is spiking due to the abundance of a new resource, data (and by proxy information.)

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Saul,

When you invest in these high growth businesses, do you pay any attention to valuation? i.e. maximum P/E to P/S that you are willing to pay?

Thanks,

GM

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When I was young and starting in investing, if a company had $25 million in revenue and was a growing company, you’d hope they’d have $28 million in revenue in year two, $32 million in year three, maybe $37 million in year four, and just possibly, IF you were lucky, $42 million in year five. That would be huge! Up more than 60% in four years!

The thought of a company growing revenue from $25 million to $400 million (instead of $40 million) the way Shopify did, in the same four years, would have seemed like science fiction!

It really is a different world.

Saul

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The rate of innovation is spiking

Exactly. How easy is it to “unsubscribe” from some of these innovations when the next new thing comes out? In the past it was difficult to change software/vendors. No more. Some of these very young companies may not live long. Or at least that’s the possibility I see.

Peace,
Dana

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Saul, I understand that it is a different world; the internet has created huge opportunities for asset light businesses to scale effectively and rapidly.

However, I’m trying to understand whether you look at valuations at all?

Thanks,

GM

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Dana,

Yes, you are right. Many of today’s high flying companies may be disrupted in the future BUT we are not marrying these businesses; if growth slows down, investors can see it happening in real time and have the option to exit.

A lot of today’s companies have built a wide ‘moat’ due to scale and networking effects etc; so it will be pretty difficult to disrupt these quickly.

In some cases, billions of satisfied customers are using these companies’ services and products daily and they have no incentive to go elsewhere i.e. Google, Facebook, Alibaba, Tencent, Visa, Mastercard

In the enterprise space, a lot of the new SAAS companies are tying up large companies as clients and they are integrating their business work flows on to their cloud software. Unless these providers really mess up; these enterprise clients won’t go elsewhere easily (high switching costs).

So, one has to try and select companies carefully; but many still have a long runway of growth.

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When you invest in these high growth businesses, do you pay any attention to valuation? i.e. maximum P/E to P/S that you are willing to pay?

Hi GM,

Actually, usually I don’t. I can’t figure PE’s as a lot of them don’t have earnings yet. And I rarely look at PS ratios. I’ve seen really smart people like Bert exit Square and Shopify at $30 plus and about $93 because he was watching “valuation,” and then had to buy them back $20 and $40 higher as I remember. What I do is look at the growth of the company, whether it seems to be a leader or disruptor in its space, whether its customers are happy (Net Promoter Score or Dollar-based Net Retention), its TAM, its moat, its progress towards profitability, etc. I figure that the power of compounded growth will take care of the rest.

Saul

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Saul, understand, thank you.

One point though:

Between 2000-2002, so many high flying tech companies got decimated and their stock prices fell between 70-80% and many lost even more. That debacle taught me that valuation always matters in the end. Doesn’t that episode bother you?

You are obviously a very, very good investor and I’m not challenging you; just trying to better understand your thought process.

Thanks,

GM

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GM,

I’m not Saul, but one difference is that many of the .com companies had no revenue and no real plan to grow revenue. Valuations rocketed higher on the premise that the internet alone would unlock a lot of value in all companies online.

The differences between the Saul type companies and those are vast.

  1. Real revenue
  2. Growing revenue
  3. Their products enable other businesses to grow and innovate
  4. Mostly subscription models
  5. High margin, scalable products (can expand to more users and improve products w/software updates vs needing more retail store space, expensive inventory, and more sales teams or warehouse teams, etc)

This doesn’t mean these stocks are immune to risk or volatility, but there really is no comparison to these companies with real, growing revenues and the revenueless, good ideas which were popular in the .com boom.

A caveat is that there were some real companies that got crushed, in the .com boom/bust, but in general, the above applies.

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I’m not Saul, but one difference is that many of the .com companies had no revenue and no real plan to grow revenue. Valuations rocketed higher on the premise that the internet alone would unlock a lot of value in all companies online.

The differences between the Saul type companies and those are vast.

Funny how we remember things so differently!

IMO, the stocks invested here are VERY similar to the same of the dot com era…near identical mantra as we heard back then:

  1. Gorilla game??..the “moat”.
  2. Rule the World??..scalable and everyone will just have to use them.
  3. Gilder’s New Paradigm??..Bert is the closet second coming…though he seems more pragmatic (perhaps from his being a previous short specialist).
  4. Valuations don’t matter??..hearing that a lot lately.
  5. Earnings dont matter because they are in growth mode??..same was said of Globalstar, Global Crossing, and so many many more.
  6. Numerus wildly bid up recent IMO’s trading on hype/promise??..look at the recent IPO’s…not the highest quality recently.
  7. Companies spinning off divisions to take advantage of stock bidding wars…seeing that recently as well.
  8. People here disillusioned if their portfolios don’t jump by 80% or a stock hasn’t doubled in 4 months??..seeing a great deal of this lately.
  9. etc.

No matter what anyone tells you, it is never different this time. During times of glorious bulls, legends are made (Gilder was one such legend…even went to a conference of his at one time in the late 90’s). Those same legends change hands when the bears run and the less than cautious bulls get slaughtered.

Been through both the Y2K and 2008 market bears…always keeping BOTH eyes wide open. Investing is a marathon…not a sprint. IMO, Retirmentdough has the best approach and one that I personally follow and have for some time.

And before you get too into the “he’s just jealous” mode, keep in mind that I believe I was one of the first to get the discussion going on MDB, NTNX, TTD and others in the past couple years. However, I am not under any illusion that I am some brilliant discriminating tech investor…I have instead gone with the momentum, TA, revenue growth and storylines to ride numerous of these stocks to doubles, triples and quadruples in a very short timeframe (SHOP, NTNX, MULE, BLUE, TTD, AAXN, TEAM, VEEV, TDOC, NVDA, TLND, BOFI, ZEN).

But again, this was very close to a dart board event as essentially all boats have been lifted. I think I demonstrated that fairly clearly with the P/S portfolios that randomly assigned to P/S just since April, returned 21%!!..mindless as it was, Still returned 21% for the lowest P/S ratios in less than 3 months!

Lastly, two points:

  1. Valuations matter…they just do. There is very often a disconnect between technology adoption and the adoption of a company’s stock. There is ample data over long periods that confirm this and even the for-fun portfolios of the stocks discussed here separated by P/S since just March returned an investment spread of 18% between highest and lowest P/S.

  2. New IPO’s more likely dissappoint in the near term…statistically…I have also presented that data as well.

This has become a sore subject for many around here so I will comment no further.

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revenueless, good ideas which were popular in the .com boom. if a company has little or no revenue, probably it’s not such a good idea after all.

The same applies to earnings . If a company can’t make a profit it won’t last for long. But there are exceptions here with great revenue but little if any profit, , and that is where this board and NPI really shines.
Conventional analysts, accustomed to analyzing low growth companies like GM, have trouble with land and expand, locked in customers, nearly free capital, and especially with compounded growth.

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Duma,

What is the Retirementdough method/philosophy?
Maybe this is for the NPI board or feel free to email me directly.

Thanks,
A.J.

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Conventional analysts, accustomed to analyzing low growth companies like GM, have trouble with land and expand, locked in customers, nearly free capital, and especially with compounded growth.

Mauser, I love it!!!

We should all copy it and place it up on our wall.

Thanks

Saul

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This has become a sore subject for many around here so I will comment no further.

Contrarians are seldom popular. Even Saul has been a contrarian, and been less than welcome. However, without a contrarian how can you sharpen your analysis?

Without a grinding stone, how will the knife be honed?

Cheers
Qazulight

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The same applies to earnings . If a company can’t make a profit it won’t last for long.

I don’t know that I would stay this any more. Revenue is needed; otherwise one is just burning capital. Cash flow is needed because one needs to spend money to grow. But, earnings are not really needed to grow the company or to be healthy. To be sure, having at least some earnings gives one a bit of a cushion if there is a temporary short fall, but having significant earnings means cash flow which one doesn’t know how to invest for growth.

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I don’t think earning matter nearly as much as growing revenue, high margins, decreasing expenses, and net rev expansion.

If a company has these, but is reinvesting for growth, I would actually prefer low to now earnings. Meaning less taxes and more money towards long term growth. This is what has worked beautifully for AMZN and NFLX.

There is certainly a difference between no earnings, rising expenses, slowing rev growth, and weak balance sheets and the companies discussed here

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Exactly. How easy is it to “unsubscribe” from some of these innovations when the next new thing comes out? In the past it was difficult to change software/vendors. No more. Some of these very young companies may not live long.

I see zero evidence of it being easy to exit a deeply embedded s/w package just because it’s subscription or cloud based or what have you. It’s not just the s/w and accumulated data that must go through some conversion process, which presents all kinds of problems when you wish to abandon one for another with “better” bells and whistles (or subscription rates). There’s the dozens (or even hundreds for a large enterprise) of dedicated internal support staff, the local experts. There’s hundreds of training hours and attendant loss of productivity due to the learning curve required for any complex piece of s/w (and virtually all this stuff is complex). There’s business process change which almost always accompanies an embedded s/w product. There’s highly disruptive moral problems and geek battles.

No company of any size takes s/w transition lightly, unless the s/w is relatively unimportant in which case the loss of that customer is probably not very significant to begin with.

It’s true that Some of these very young companies may not live long which is exactly why you see such an emphasis on “land and expand.” The longer they are part of the business and the more functionality a customer embraces the more difficult it becomes to head for the exits. Saul hasn’t come right and said it in those terms, but the proxies for how deeply embedded s/w os are the promoter score and dollar based expansion rate. When those numbers are high, it’s solid indication that the s/w is becoming more and more deeply embedded. Embedding makes it very costly (both tangible and intangible costs) to transition to something else.

And there’s also the network effect where success breeds success. Twilio is a great example. If you’re hiring folks to deal with telephony are you going to be able to find people who are productive on day one if you’re using brand X? If you’re looking for noSQL DBAs do want to be in Cassandra or MongoDB? OK, maybe the jury’s still out on that one, but IMO, not really. It’s already a closed case. If I were still an enterprise architect MongoDB would get my vote without a second thought.

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Hey Duma

just wanted to say that I really appreciate your posts. As qazulight said, how else can we refine our own approaches?

cheers
Greg

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It’s true that Some of these very young companies may not live long which is exactly why you see such an emphasis on “land and expand.” The longer they are part of the business and the more functionality a customer embraces the more difficult it becomes to head for the exits. Saul hasn’t come right and said it in those terms, but the proxies for how deeply embedded s/w os are the promoter score and dollar based expansion rate. When those numbers are high, it’s solid indication that the s/w is becoming more and more deeply embedded. Embedding makes it very costly (both tangible and intangible costs) to transition to something else.

There is one other thing, the Glass Door rating. With these companies having good people is critical. If an upstart wants new programmers he has to build them himself. Same with other creative talent.

What is the chance that At&T is going to grab enough of the really good programmers from
Amazon to make a significant difference in its software suite?

Will Ikea be able to pull the talent from Shopify to build its online presence.

(In both cases if they could they should.)

The only way most of the big boys beat the upstarts is to bully or buy.

Cheers
Qazulight

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