Calming perspective

Investment Analysis Clubs Saul’s Investing Discussions
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I appreciate Endoscopist’s link here: https://discussion.fool.com/i-am-down-quite-a-bit-in-my-portfoli…. The article was dated Dec 13, 2021, and it showed 5 SaaS pullbacks in the last several years, including the one in early 2021 and the one in late 2021. That late 2021 pullback is either still ongoing and has become the most significant pullback yet, or we have had another pullback (or several) in early 2022. However you look at it, the result is the same: valuations are compressed.

Well thanks, Captain Obvious. But I wanted to get some perspective on how compressed. Are valuations really low? Of course they can always get lower, but how do they compare to how they looked before everything got so crazy expensive in the run-up to Oct/Nov 2021?

No valuation metric is perfect, but we’re all familiar with Price to Sales or Enterprise Value to Sales (EV/S). Taking the concept further, Enterprise Value to Next Twelve Months Sales (EV/NTM) looks a year ahead which takes into account growth rate, but of course the obvious caveat is that we don’t know what growth will be in the next year. So Jamin Ball (https://twitter.com/jaminball) uses guidance (I think), which obviously makes his EV/NTM metric conservative, as companies plan to beat guidance quite substantially.

Still, as a very rough indicator, I think it’s useful. So, using Jamin’s data, I tweeted about it back in January, and I updated the info just now: https://twitter.com/investing_bear/status/151780906394131251…

My take away from the exercise is that we really are at a level where opportunity abounds. For evidence, just look at my top 3 holdings. Datadog and Bill.com and Zscaler are growing faster than ever. And yet their valuations are even lower than the reasonable levels of early 2021 – before the run up. I don’t expect a return to the insane levels of mid to late 2021, but for valuations to go much lower I think the companies’ growth would have to grind to a halt. I know there are fears of interest rates and even recession, but none of that is anything that hasn’t happened before. Covid was something that hadn’t happened before, at least in our lifetimes, and these companies grew through that. I think we should expect the world to go on spinning, and the cloud to keep on growing.

A simple, but for me, a calming thought.

Bear

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And yet their valuations are even lower than the reasonable levels of early 2021<\i>

What makes 25x reasonable? Is it because 25x is half of 50x?

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So Jamin Ball (https://twitter.com/jaminball) uses guidance (I think)

He stated back in July: NTM estimates represent the median consensus estimate of all sell-side analysts who cover the stock.

https://cloudedjudgement.substack.com/p/clouded-judgement-79…

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It isn’t just “Saul stocks”. Everything is down. COST, V, my company…everything. “The Market” is reacting to a bunch of stuff, independent of company fundamentals.

I would be much more concerned if my companies were going down while everyone else is going up. But that’s generally not what’s happening. Doesn’t make the paper losses we’re all seeing feel any better. But until company fundamentals change (e.g. NFLX, with their reduction in subscribers), I’m not really worried.

1poorguy (long COST, V, and NFLX**, plus some stocks followed on this board)

**Yeah, gonna have to rethink NFLX. Their growth was slowing, but this caught a lot of people by surprise.

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My take away from the exercise is that we really are at a level where opportunity abounds. For evidence, just look at my top 3 holdings. Datadog and Bill.com and Zscaler are growing faster than ever. And yet their valuations are even lower than the reasonable levels of early 2021 – before the run up. I don’t expect a return to the insane levels of mid to late 2021, but for valuations to go much lower I think the companies’ growth would have to grind to a halt. I know there are fears of interest rates and even recession, but none of that is anything that hasn’t happened before. Covid was something that hadn’t happened before, at least in our lifetimes, and these companies grew through that. I think we should expect the world to go on spinning, and the cloud to keep on growing.
In general, I am right with Bear on this. I do want to add a few points.

Covid hadn’t happened before, but software companies clearly benefitted from Covid. The move to Work-from-anywhere and the implications to the move to Cloud are entrenched now, but that was a slower movement pre-covid. The digital transition got a boost and I feel it’s early days. Analysts are being very conservative in their estimates (compared to company guidance). Jamin’s numbers use 12 month forward revenue from analyst estimates.

The early 2021 valuation levels you are using as a benchmark were in fact much higher than historically true pre-covid. I can see arguments for comparison to those levels instead. But I can also see the argument that the digital transformation train started in 2020 and growth rates jumped with that train ride. Comparisons prior may be less meaningful.

Yes, Datadog and Bill.com and Zscaler are growing faster than ever. In fact, as I’ve pointed out prior, Jamin’s high-growth cohort is defined as >30%, but the average member of that cohort has been growing well above that rate and certainly well above the averages for 2019. So the valuations are in effect much lower than pre-covid for many of these companies. Analyst estimates have also reflected lower growth rates expected, a more conservative take than that of the CFOs.

The real question remains. Will these companies continue to grow “faster than ever” given coming Fed actions and potential recession? And there’s a 3rd concern, which is Putin is now using the threat of Nuclear attacks as a blackmail tactic, and playing chicken with Western Europe regarding Oil, Gas, and potentially crops (Donbas). Clearly, Putin has adopted a more aggressive attitude to markets and Russia’s position. This has implications that should be considered, just not within this board.

We are back to early 2021 valuations, and I’d argue we are lower that that in reality, as the growth rates have been much higher for his cohort. We expect that our companies will grow higher than pre-covid rates (much higher than 30% as a cohort), but the macros mentioned above create more uncertainty than early 2021. So it all comes down to sustainability of growth rates and the market has priced in that they fear that they are not sustainable.

Microsoft will probably shed some excellent light on this in a few days.

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I can’t truly know what’s baseline, what’s expensive, what’s euphoria, or what’s cheap…but I’m happy to share my opinons: https://twitter.com/investing_bear/status/152297977600004915…

Hope that is calming/settling for some. We can’t know where things will go, but we can and should know where we’ve been and where we are. At least, as much as it is possible to know (estimate).

Also, even some readers here have posted in the last few days that they might be “done,” or are “tapping out.” Seems encouraging to me that a lot of the selling (or at least ceasing to add) has already happened. But who knows?

As I said on the image in the tweet, it doesn’t matter how “cheap” things get if they aren’t solid companies that will continue to thrive come what may. Let’s stick to discussing that, here. I feel incredibly good about Datadog and I feel good about many other companies we own and discuss here. That is what we should focus on – picking. The winners will win in the long run. We can’t control anything else.

Bear

PS - Perhaps you (or I) should only have a certain percentage of your portfolio, or net worth, or whatever, in growth stocks. Each of us must decide for herself or himself. Let’s not discuss that on this board.

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