Market thoughts:
Sell-off in high growth stocks continued . It seems it will never stop. Some days, it went green in the morning and turned red in the afternoon. It felt hopeless sometimes. It was a very difficult time for hyper growth investors.
During major market corrections,there are all kinds of negative thoughts in our head. People may say: “there’s literally no bottom. “(Come on ! Really? There’s bottom even for LSPD , DOCU and ZM! Not to mention high quality growth stocks!), “SaaS stocks will be destroyed?”(Come on ! Really? Sky is not falling. World is not ending.), “Thinking of selling all individual growth stocks and buying stable and defensive ETFs”(Bad choice to sell low) . Precisely because of those kinds of thoughts or actions, the market fear was closed to maximum. When market fear is at maximum, the market is closed to the bottom. (You can check out VIX index peaks vs market bottoms) The interesting thing about market fear is it takes energy to be fearful. Once the fearful energy is exhausted, the fear will plateau and decline gradually even if the negative effect of the event has not gone away. e.g. The fear peaked and the market bottomed and steadily recovered while the negative effects of GFC, COVID still exist, Same will be true for interest rate increase. 2018 was the proof.
I endured the March, 2020 COVID market crash. I sold out stocks completely during Feb to March, 2021 SaaS sell off.(big mistake! As I sold low and bought high months later costing me 30% gain.)
In this sell-off, I finally got it and it didn’t sell. I kept my composure. I kept reminding myself that business results drive stock prices and not the other way around. Stock price dropped 50% but the business didn’t decline 50%. This SaaS selloff felt worse than the last two corrections and it is. This time, Cloud stocks dropped slightly more than during COVID 2020! During COVID 2020, Cloud ETF: WCLD declined 37.7% from intraday high to intraday low. During Spring, 2021 correction, It declined 28.16%. During the latest Dec, 2021 to Jan, 2022 correction, It declined 39.93%. The irony is during this latest growth stocks selloff, the US economy is doing the best than the last two corrections. US unemployment is at one of the lowest levels of 3.9%. (Canada is a lot worse at 5.9%!) US GDP is almost back to pre-covid level inflation adjusted. (https://www.nytimes.com/2022/01/27/business/economy/gdp-repo…)
In fact, the reason for this sell off is only due to two main reasons: 1. Rich valuation 2. Interest rates increase due to high inflation because the economy is running too hot and the supply chain constraint. But the real reason they have to raise the interest rate is that it needs the buffer as a tool for the next recession because they need to lower the interest rate to stimulate the economy or else the rate will go negative next time.
At the end of Jan, 2022. After seeing stocks go green in the morning and red in the afternoon many days in a row.
I told myself“ I don’t care about price drops anymore. “
Why?
Omicron
Omicro is proved to be a short term scare like Delta. I’ve read in the news that Omicro got some DNA from a common flu. That’s the reason it spreads so fast. At the same time, it’s also less deadly than previous waves. COVID-19 was around 10 times more deadly than the common flu. Omicron is half as deadly as previous variants, that makes Omicron 5 times more deadly than common flu.
Interest rate/inflation
The 10 years treasury bond yield was around 2% pre-covid. It dropped to 0.5% during COVID and it’s likely to go back to preCOVID level of 2%. What’s the big deal about going back to 2% to 3%? It’s still at historic low and it’s unlikely going much higher to 5% or 10% because of the worldwide aging population and the long term decline of natural interest rate.
http://research.stlouisfed.org/publications/economic-synopse…
I still believe inflation is transient. Once pent up demand is exhausted, people buys services instead of goods, supply chain improves, inflation will subside by the end of 2022. Take energy as example, the major source of inflation,
Oil price change:
April 2020 to April 2021:$18.8 to $63.6, +238% YoY inflation! (338% of where April 2020)
Feb 2021 to Feb 2022: $61.5 to $88.6, +44% YoY inflation (144% of Feb 2021)
See the pattern here? Oil prices can’t grow exponentially indefinitely. Energy price growth will slow down and go sideways Year Over Year very soon. That means 0% inflation from the energy component soon.
Market correction
I observed that the higher the expected return, the higher the volatility.
Cash doesn’t fluctuate so it feels safe but it loses to inflation.
It’s normal for 10% growers to correct 10% once a while. (e.g. index)
It’s also normal for 50% growers to correct 50% once a while. (e.g. hyper growth stocks)
So this means if the index dropped 10%, it’s not the end of the world.
So this means if hyper growth SaaS stocks dropped 50%, the sector is not getting destroyed.
If you want hyper growth return, you need to be able to withstand a 30% to 50% drop in portfolio or networth once in a while. Raw dollar loss is scary if millions of dollars is involved, that’s why people said: “SaaS getting destroyed? “ However, the longer we are invested, the more buffer we have. After a few years of gain, even if it drops 50%, we are not back to the beginning. Therefore, the ability to withstand large portfolio declines in the first year of getting into concentrated hyper growth is essential to master this style of investing or get out and back to index funds or whatever.
This idea is extremely hard to grasp. Even I feels stressed during such corrections. As I get more serious about hyper growth style, I studied companies more and formed stronger convictions, not just guess work. I feel having more composure. I even added to each of my positions during the scariest time on Jan 28, 2022.
News headlines:
Be wary of news headlines. I realized how news headlines affect our mood or even decision making.
In January, I’ve seen many news headlines like: “High growth tech stocks are flaming piles of garbage, stay away as far as possible and get into safe sectors: energy, financials, utility etc.” (paraphrase) They actually showed a graph showing large amounts of funds flowing out of growth into those “safe” sectors. They just want lots of readers so tend to exaggerate current situations. Few days later after the market rebounded, they interviewed the ServiceNow CEO telling us tech stocks are oversold but the editor still said high growth stocks were the worst trade of the past 3 months. We are not traders. We buy and hold! So uninformed investors will be easily influenced by those random news headlines and jump in and out of different stocks/ sectors…
Stay focused on what really works:
Buy and hold high quality hyper growth companies as long as the thesis has not changed!
Portfolio thoughts:
The best thing to do during major market corrections is do nothing. The portfolio result will likely be worse if major change is made during a big crash because that’s when we are most emotional.
I am two years into growth stocks style and one year into concentrated growth stock style.
There’s one big lesson I learned in 2 years: we HAVE to stay invested to have a market beating return. There were two reasons to underperform: 1. Indecision about high quality hyper growth stock and allocate too small of percentage so they won’t move the needle for the portfolio. 2. During market correction, sold out all growth stocks and moved to cash or other lower return styles of investing vs concentrated hyper growth.
Since the end of 2019, It’s crazy I under performed vs my 200 stocks I picked during the end of 2019 because of the above 2 reasons. But since I have composure now, I will likely not repeat that same mistake.
I have not heard any major negative company bad news from my holdings to justify a 50% drop. The companies I am holding are not Zoom Video, Docusign, Peloton etc… The companies are still growing at hyper growth rate as far as I am aware of. Unless the next report shows a dramatic slow down, I don’t see a reason to sell in panic. In fact, from the reports from the past few weeks, many tech/SaaS companies, even Visa, reported good earning reports. (Fast growing GDP and high inflation means more tailwind to company top line revenue growth)
What did I do in January?
No selling and switching around positions. What I did was on January 28, 2022, I used a modest amount of margin(10% of total portfolio value) to add an equal amount to each of my holdings because I couldn’t believe how cheap they became and couldn’t resist. Adding a 5% to 10 % to total return this year doesn’t make a big difference to my life so it’s less about money. It’s more about how I didn’t want to miss out on the rare opportunity. It’s a calculated move. I know how to calculate margin excess and drawdown limit on that account(another 65% drop in my case). And this account is only half of my total portfolio value. I also have cash set aside ready to be deployed in the worst case scenario although I don’t believe the SaaS stocks will drop another 65% after it’s already down 50% from ATH given the excellent earning reports from other tech companies in recent days and strong US economy. I don’t recommend using margin for most people. Next time, I will likely build up more cash reserves for situations like this. This is not about market timing because I keep most funds invested at all times. Those positions are already up a total 15.78% in 2 days as I am writing this report. I expect a 50% to 100% return within 1 year since they were extremely oversold (50% from ATH) due to a small interest rate increase to pre-covid level of 2%. This is not unrealistic if you look at how much hyper growth stocks bounced back from bottom in the past. E.g. in 2021.
January, 2022 monthly result:
Portfolio: -24.80%
SP500 -5.27%
WCLD -13.96%
**Allocations as of January 31, 2022:**
**Ticker Allocation January price change**
BILL 17.71% -24.46%
MNDY 17.47% -32.20%
SPT 11.43% -24.08%
NET 11.40% -26.69%
MDB 10.52% -23.47%
DDOG 10.10% -17.97%
CFLT 9.70% -14.23%
DOCN 8.53% -28.62%
SNOW 3.07% -18.55%
I didn’t make major changes so their allocation changes are due to their different price changes in January.
My conviction level:
I have two conviction levels: high or medium. I don’t have low conviction companies. If it’s low conviction, I don’t include it in my portfolio. I am wrong sometimes. That’s when I think a low conviction company is a medium/high conviction. I get out when I realize I made a mistake. Both high/medium convictions are high quality businesses. The difference is that a high conviction company offers potentially a higher return than a medium conviction company. As I mentioned, I allow companies with different growth rates in my portfolio ranging 40% to 100% growers or slow growers accelerating.
I tend to allocate more funds to high conviction companies but sometimes I allocate small percentages to high conviction companies due to many factors: 1. Out of cash and I don’t want to sell others. 2. High valuation. 3. Starter position
High conviction: MNDY, BILL,SNOW
Medium conviction: NET, SPT, DOCN, MDB, DDOG, CFLT
Companies comments:
Monday (MNDY):
I noticed a few people sold out of MNDY because they were disappointed by MNDY’s stock price movement. and used many excuses:
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“Israel is a small country with a small GDP”. My answer: The size of the country is irrelevant. MNDY is a multinational, offering SaaS service delivered over the internet with most revenue generated outside of Israel. Besides, Israel is a very competitive highly developed country. It has a GDP per capita of $43,610.52 USD (2020) , a highly educated population, many tech innovations, nobel prize winners and even possible nukes. Also, there were many winning Israeli stocks: ZIM, INMODE, WIX. In fact, the Saul board invested in Wix years ago. Finally, Israel has a good relationship with the US.
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“There is no moat, too many competitors,a crowded space.” My answer: Most companies have competitors. It’s very rare for a tech company to be a monopoly, or duopoly in the world. E.g. Samsung and Taiwan Semiconductor Manufacturing Company for cutting edge chip fabrication tech.
The consistent above average customer and revenue growth rate indicate MNDY is doing something right and customers like it.
I found it odd because the stock market is inefficient in the short term. Nope, the companies didn’t suffer 50% business deterioration in matter of 3 months. They didn’t have true convictions if they had self doubt because stock prices declined substantially. Sometimes the market is right but most times not. The MNDY stock decline was compounded by lockup expiration with unknown amount of shares released and severe SaaS selloff.
Let me give some examples: it’s normal for a new IPO to decline even if the company is doing great.
-Crowstrike stock went sideways for 8 months after IPO. (0% return)
-Zoom Video stock also almost went sideways for 9 months after IPO. (0% return)
BILL.COM (BILL)
Many people don’t like the growth from acquisitions. I get it. They complicate stories. I don’t like acquisitions either if acquisitions are slow growing non-competitive companies.
The reason BILL acquired Divvy and Invoice2Go is it plans to become an all-in-one financial operations platform for SMBs. Those two acquisitions provide cross selling opportunities and increase the stickiness of the BILL.com platform. Divvy stands out with stand-alone revenue growth of 187% YoY! Divvy Card spends increased 160% YoY! Note Divvy is free to use but it makes money from credit card transactions. It gets a cut from the merchant fee from banks and VISA.
Both DIVVY and Invoice2go serve to expand BILL’s TAM and fulfill the goal of all in one platform. DIVVY hyper growth can add to top line revenue growth while BILL can learn from Invoice2go on how to expand internationally.
Cloudflare (NET):
1 or 2 years ago, I only thought of Cloudflare as a provider of DDOS protections. As I learned more, Cloudflare is impressive at how fast it churns out new products/services by trying out new ideas and tested by a large number of users every year allowing fast to market and thus keeps expanding TAM. It reminds me of big tech companies like Google where they have side projects and later they became major revenue generators. I won’t complain about 50% per year growth if it can steadily grow at the rate for many years. I see signs that growth is accelerating. The addition of R2 revenue should further accelerate growth.
Sprout Social (SPT)
It could be the Apple privacy change that affected FB and indirectly affected Sprout Social. But privacy change affects advertising revenue and should not affect social management tool revenue as long as people are still using social media.
Digital Ocean (DOCN):
I did a writeup on why I bought it:
http://discussion.fool.com/why-i-bought-digital-ocean-docn-34989…
Total customer base has a high churn rate so it doesn’t show the whole whole picture. The real growth comes from the small customers that grow bigger.
I don’t mind the slightly below average growth rate of 40% because it has signs of acceleration…
I like the idea of Digital Ocean serving a large number of startups and growing as they grow.
The company is also well run financially. It has a large amount of cash and no long term debt. It’s rapidly approaching positive net earning per share.
MongoDB (MDB)
MongoDB is a general purpose enterprise grade database.
Its main revenue growth driver is: Atlas cloud
Data will keep growing so I think MongoDB can grow at high speed for a long time.
In December, MDB MongoDB released earnings.
Total revenue: up 14.2% QoQ sequentially.
Revenue excluding Atlas cloud: up 9% QoQ sequentially.
Atlas cloud revenue: up 18.3% QoQ sequentially. It continues to constitute a higher percentage of total revenue. Now it sits at 58% of total revenue. It should climb to 80% in a year.
Analysis:
-QoQ: 14.2% is the fastest since early 2019. Clear re-acceleration
Medium term expectation:
-20% per year growth in non-cloud revenue
-80% per year growth in Atlas cloud revenue
Overall revenue growth: 60% per year, slowly accelerates to 70% per year.
-Atlas revenue is currently 58% of total revenue. It was just 22% 3 years ago. Because Atlas Cloud revenue is growing faster than non-cloud, Atlas revenue will make up around 70% in 1 year, 75% in 2 year and 80% in 2 year. It’s unlikely to reach 100%.
Note: MongoDB has big seasonality in quarterly revenue but its long term growth trend is intact.
Datadog (DDOG)
Not much to add to this favorite of the board. Its steady growth of revenue and customer shows its TAM is massive.
-Revenue growth averages about 70% per year. It accelerated nicely from COVID slowdown.
-Customer growth averages 50% per year
Confluent (CFLT)
Confluent claims to want to be the central nervous system of companies. It’s the only cloud naitive Kafka platform. Data in motion is a relatively new type of data platform vs static database to allow large bandwidth data streaming.
Confluent vs MongoDB similarity
First of all, their products are different: MongoDB is a database where you store the data at rest. Confluent is a data stream where data is processed dynamically in real time. It’s Data In Motion.
The similarity lies in they are both based on an open source project. Both have naitive cloud hosting services based on the public cloud provider: AWS, Azure, Google cloud. And in each case, cloud revenue is the main revenue growth driver because cloud revenue is growing much faster than others.
As of last quarter: MongoDB Atlas revenue was 56% of total revenue.
As of last quarter: Confluent cloud revenue was at 26% of total revenue.
It seems to me Confluent is in an early stage of growth vs MongoDB (a few years) and can have years of growth ahead of it. If MongoDB stock did well, so will Confluent stock! It helps to compare similar business models of different companies.
Some will ask what about competitors for Confluent ? Well, there are many databases available. MongoDB is just one of them. MongoDB did well. Likewise, Confluent is one of the data stream products. I think the market is big enough for many players. I also read many times that Confluent(kafka) is one of the leaders in the data stream. Kafka is one of the top open source projects and Confluent employees are major contributors to the open source project.
Snowflake (SNOW):
It has no sign of slowing down suggesting the TAM is massive.
I think data warehouses are a sticky business model. As the data grows, there will be more and more old data. To do data analysis, they need to look at all historical data. There was some concern about RPO deceleration from the past 3 quarters. The 18% QoQ increase in RPO shows it’s not permanent deceleration. I think what happens is that customers do a bulk purchase once a year or so. As they use up the credit, they make new purchases again.
Disclaimer: This portfolio update is not investment advice and you should do your own research.