I admit, that’s a click-bait title. But hear me out. This is a response to a recent post by Brittlerock (https://discussion.fool.com/saul-i-fully-understand-and-agree-wi…) which I think encapsulates two things:
- The angst some of us are feeling over the valuation contractions for our stocks
- Confusion about whether “valuation matters.” (Some people think Saul says valuation doesn’t matter…I’m not sure about that.)
My take on #2: of course valuation matters. Why is Amazon worth more than Zscaler? If valuation doesn’t matter, there is no reason.
Brittlerock said: I think valuation is important if for no other reason because it is important to other investors
Well, I think valuation is important because things have value – even if we can’t pinpoint what that value is. We know it when we see it. Amazon is worth more than Zscaler. Microsoft is worth more than Shopify. Google is worth more than Chipotle. On that scale, no one debates these statements: they are facts. But should Zscaler be worth more than MongoDB? Or should Zscaler be worth 12 billion or 6 billion? The answers there are less obvious.
The reason some things are worth more than others is because of what they are likely to do in the future. That’s not a perfect way to put it, but you get the idea. Google is expected to generate billions in profit each year, for many years – probably decades – to come.
Now what about #1? – the angst. Brittlerock concludes What to make of all this with respect to investing decisions? He didn’t say what decision he was struggling with – He mentioned that he hasn’t sold everything to buy gold – but I think we all wonder sometimes if we should take money off the table.
What I do is compare all the companies I own, or am considering owning, on a daily basis. Usually things stay within ranges I find reasonable, and so I don’t adjust anything based on relative valuations. But recently Zscaler had a PS ratio 50% higher (maybe more) than other somewhat similar companies. It was fair to ask why. I didn’t know why, so I reduced my position. Now that ZS is back in a reasonable range, I’ve added back. I’ve done the same with CRWD and OKTA.
What might be more scary is that the market seems to have re-priced the set point on the kind of stocks we own. We don’t know that there’s a floor there. Actually, there isn’t in any literal sense. The market could decide these amazing companies are only worth a PS ratio of 10, or less! But I don’t think that will happen. Because on every trade there are two sides. And if these stocks are sold below a certain floor, savvy investors will swoop in. The secret is out. Not only is the SaaS model powerful, but these companies have game changing products. As long as they have the best offerings and their customers keep needing what they’re selling, they’ll have more and more revenue in the coming quarters and years, and they’ll become more valuable.
We can’t expect the market to be reasonable. The market is over-correction personified, and stocks are wild stallions. When hot, they run up far beyond what logic or analysis can support, and when out of favor, they fall to levels beyond “cheap.” But we can expect buyers to be greedy, and some of them to be smart, and to know a great deal when they see it. So we can expect our companies to have a floor. We just can’t pinpoint where, or when. So just make sure you can ride the waves down and then back up again, and then up further and further. Don’t mortgage your house to buy at these levels – or any levels! But don’t get out at these levels either. We have to be patient.
I’m not sure how comforting that is. It helped me.