“We invest in them because they are executing wonderfully and often have some of the best founders and lesdership teams managing them”
Austin,
The slight problem is that the financial community also feels this way : which explains the 20, 25 or 30 P/S ratios! We are not talking about P/E ratios here, but P/S ratios!!!
Whether my posts are pointless or not, only time will tell. It might be a bit premature on your part to reach this conclusion.
Last I’ll post on this thread as it is far OT at this point.
I did not call your post pointless, just that fact/example about the highest P/S stocks underperforming the market.
My point is that we don’t invest because they are the highest p/s stocks. Those could be some terrible businesses if high p/s is all we looked for.
We look to invest in the best businesses and I believe (so does David Gardner) that over the long-term (he has 20+ years of history) that by investing in the best businesses we can far outperform the market.
So I don’t think my conclusion is premature. Now what’s up for debate and still to be concluded is whether or not we are actually currently invested in the best businesses. That’s what we won’t know for another 5, 10, or 15+ years.
But with that being said, we’re not locked into these businesses. We can certainly sell them if their performance begins to falter.
I’m not gaining anything by posting these facts here; but am only trying to highlight that (a) perhaps these SaaS stocks are not immune from the stock market/business cycle (b) historically, stocks trading at the highest P/S ratios have been the worst performers.
One important thing to note is that any highly valued stock will be decimated in a bear market, even if its underlying business benefits from the economic event that triggered the stock market decline.
Case in point is the '73-'74 bear market that was brought about - mostly - by the collapse of the Bretton-Wood system and the oil crisis of '74.
Both of these events had the effect of driving up gold prices enormously.
Gold stood at $64.99 at the beginning of 1973. On January 2 1975, it stood at $185.00, almost three times as high.
Newmont Mining opened the year 1973 at $11.47. Two years later, it stood at $7.61, a loss of a third.
And I don’t even think Newmont was highly valued at the time. More speculative gold miners suffered even worse.
The same applies for oil companies. Oil prices went up ($21 to $54), oil stocks went down (Exxon: $2.81 to $1.98).
https://www.macrotrends.net/1369/crude-oil-price-history-cha…
https://www.macrotrends.net/stocks/charts/XOM/exxon/stock-pr…
Note that neither Exxon nor Newmont were speculative companies at the time. The oil crisis and Bretton-Woods greatly improved their business outlook, but their share price got clobbered anyway.
The reason for that is that stock market valuations are comprised of two elements: the underlying tangible earnings, and investor risk appetite (a.k.a. as “hope”).
The higher valued the stock is, the bigger the influence of the second component.
A company with a huge EV/S is valued almost entirely on the basis of “hope”.
And if that hope goes away, then the stock falls. A lot. Even if the underlying business performs as expected.
At the bottom of a bear market, investors are as unreasonably bleak in their assessment of the future as they were exuberant at the top of the bull market.
If the SPX falls by 40%, the high-flying SaaS stocks will fall by 60%+ even if their business outlook is untouched. Which it probably won’t be, as business investments are always cut back during recessions.
Expect highflying stocks of all kinds to decline by 75% in the next recession, probably by substantially more.
The golden rule, as always, is:
You should position yourself so that such decline and the simultaneous loss of your job doesn’t ruin your life.
AdvocatusDiaboli,
I couldn’t have said it any better myself, which is why I hedge my growth stock portfolio during stock market downtrends.
Although… I don’t know if all growth stocks will fall by 75% in the next recession, there is just no way of knowing that now.
Best,
GM
I just find it extremely ironic O’Shaugnessy researches and compiled into a book “what works on Wall Street” then proceeds to trail the indexes.
Although… I don’t know if all growth stocks will fall by 75% in the next recession, there is just no way of knowing that now.
Well, historically, stocks have always gone down significantly during recessions, the higher the valuation of the market, the bigger the fall.
https://www.advisorperspectives.com/dshort/commentaries/2016…
There is a clear correlation. Can you find ANY historic precedent where, during a recession, highly valued growth stocks HAVEN’T declined substantially more than the broad market?
While you are right that we cannot positively know that history will repeat itself, based on the greed/hope/fear/despair dynamic that drives the stock market, there doesn’t appear to be a good reason why it shouldn’t.
As long as investors as a species don’t change, we should expect the stock market to behave in general as before. And what I’m reading here sounds pretty much exactly like was I was reading in 2000 and 2007 with regard to various highflying stocks, so I think the assumption is pretty safe that history WILL repeat itself.
I have a fundamentally different perspective on long-term bond yields. I do not believe that the treasury rate will exceed 5% during the 21st century.* Probably it won’t even go beyond 4%. The reason is that the end of the industrial revolution and the decline in the working-age population within the developed world (and China) is causing a permanent capital glut which drives down the natural interest rate below the zero bound (absent government deficits or real estate bubbles). So this is an example where there is good reason to expect the future to be very different from the past.
But in the stock market, recessions cause fear, fear drives down prices. This will not change.
*absent an aggressive policy shift towards chronic helicopter money injection, i.e. every US citizen receives a monthly cheque of $100 from the Federal Reserve.
Just out of curiosity, I had a look at MSFT’s 1986 financial statements, and it appears that it has a market cap of approximately 1 billion dollars at the time, a trailing P/E of about 23 and a P/S of 5.
https://digitalcollections.lib.washington.edu/digital/collec…
If I ever have time, I might check out MSFT’s valuation at various market inflection points.
There are obviously some strong opinions on this issue. I think most of us would agree that the SaaS stocks most followed here have unique opportunities, and if the business are run well and the market behaves shareholders will be rewarded.
But let’s not forget that there is a pattern that when investors think they’ve figured something out about the market, it changes. Long term patterns hold – sometimes. Relative strength works – sometimes. The point is to be careful not to over stretch such that you can’t make it through an unexpected downturn – because it’s always unexpected, otherwise everyone would have avoided it. It happens quickly, because everyone is trying to avoid it.
It is really hard to start again if you lose everything, and very painful. There really is no reason to risk it all. I’ve gotten to close to that. Be prudent and have a little patience. The hurry to make money too fast is what kills portfolios. If these SaaS companies pan out like we hope, we won’t need to invest everything in them in order to be successful.
Enjoy,
Brian
Okay great thread but I think it’s gone on long enough. Please no more replies. Reply to each other off board if you’d like to continue.
Can you find ANY historic precedent where, during a recession, highly valued growth stocks HAVEN’T declined substantially more than the broad market?
And, what have those growth stocks done relative to the rest of the market after the bottom is reached … assuming, of course, that there is no permanent injury done to the company in the process?
The real downside to higher EV/S stocks is if you buy closer to the top and SELL near the bottom.
As Saul mentioned, he got enough of a head start vs the market that when the bear came for us in December, he was STILL up north of 40%…
Furthermore, let’s say you buy near the top, if you just HOLD these great companies throughout, you’ll outperform in the long-term(unless you really DO wanna sell at the bottom 
)
Being in my 20’s, I can be EXTREMELY patient but I think this really applies to everyone here.
Don’t overthink things and enjoy the process, our results are truly incredible.
Best,
Diego
And, what have those growth stocks done relative to the rest of the market after the bottom is reached … assuming, of course, that there is no permanent injury done to the company in the process?
I can think of AMZN as an example, which took more than 10 years to exceed its 2000 high.
And Amazon is one of the few true success stories of the 2000 tech bubble.
CSCO has still not exceeded its 2000 high.
Eyeballing its chart and valuation, I expect that it’ll take another 5 years until it conquers that high on a sustained basis (i.e. not only temporarily in some kind of market blow-off).
I can think of AMZN as an example, which took more than 10 years to exceed its 2000 high.
And Amazon is one of the few true success stories of the 2000 tech bubble.
How often since there was a stock exchange in NYC have there been bubbles as large as the tech bubble? Ten? Twenty? Sorry but it’s a “Chicken Little – the Sky is falling” tale. Of course one has to be prepared but not so scared as to become immobilized.
A 120 year chart to ponder
https://virtueofselfishinvesting.s3.amazonaws.com/uploads/re…
Denny Schlesinger
