Eye of the storm

Hi everyone,

I have been with this board and investing for about 15 months now. Posted a couple times, when I felt it was relevant. This is one of these times. My work is problem-solving, so I am hoping to bring some value today by helping us solve our biggest current issue: people acting on their emotions, mimicking the market behavior.

What is this board about ?

When I first read the Knowledgebase, and then re-read it many times, the few things this board is about became obvious to me:

  1. Numbers: this is a place to follow numbers. Not price action. Not bear/bull market. Not your boss being rude to you. Not your mom asking you to clean your room. Numbers.
  2. Story: matters as much as numbers. We look at CEOs, ownership, product teams, incentive, and much, much more.
  3. Theories: Based on the 2 elements above, stories and number, we create theories for the company we hold.

What does this mean, concretely ?

  1. Holding periods: While they may vary, Saul clearly indicates that they would range between a couple months and a couple years
  2. Revisiting theories: based on changes in stories and numbers, we revisit our theories, trying to always optimize our portfolio based on current knowledge

What is not considered here ?

  1. Complex portfolio management: yes, might be beneficial right now to sell your stock before earnings, and buy them again right after. Or not. That’s on you, because it doesn’t tell us anything about stories, or numbers
  2. Market craziness: I fully acknowledge these are crazy times. In fact, the moves of the nasdaq today, of 6% amplitude, hadn’t been seen since the covid crash. Wow! Why do we not consider that ? because it doesn’t tell us anything about stories, or numbers
  3. Valuation: this is a tuff one. I’ve realized by now, it’s necessary to understand (my 15 months result are lagging board leaders by a good 30%, in major part because of this). But, you guessed it … because it doesn’t tell us anything about stories, or numbers

So what is the solution ?

Well, its actually pretty easy. Like most things, hard to implement, but easy to conceptualize.

  1. We have to stray away from letting price influence conviction. Posts like “ZS Miss” that just plainly post ER, are just a manifestation of people unstable emotional state. Believe me, I get it. I am down 28% on my initial investment as of today. It’s not fun. But this board has been the eye of the storm , and we need to keep it so. Otherwise, it stops being the exceptional learning vehicle it is currently.
  2. We have to lower the amount of posts. I know, I just did the opposite. But seriously, in the past few months, if we calculate the share of reco-worthy posts, it has decrease at an accelerate pace, as the market situation deteriorated. Yes it sucks, but give room to our board leaders to help reassure you, and even partially hold your hand as you go through your first or second major, major drawdown (my portfolio is down 56% from its November high as we speak).
  3. we have to stop micro-scrutinizing numbers. You heard it right. These are COMPANIES we are talking about. Do you think them landing at 13% instead of 15% QoQ growth should entirely change your conviction ? Come on, we function better than that. Let us take the time to review numbers, and stories, and come up with a revised conviction. I guarantee you the swings in your portfolio will be much smaller. It’s gotten to the point where people sell-out entirely at ER, just to rebuy 40 minutes later. That isn’t stories and number. That’s fear and greed !

Hoping that this post will be helpful for the majority of readers. I understand it might not be for board leaders immediately, but I am expecting that getting back to the eye of the storm will be.

Cheers,
Ys

229 Likes

A quick, but necessary response….

The issue isn’t the stocks mentioned here….It is allocation….

If UPST, MNDY, ZS, NET, etc…were only 3-5% allocations instead of 10-15-20% positions, I will bet with my last dollar that people would be less reactionary and more likely to focus on the business, not the stock price….

And what business doesn’t eventually hit temporary headwinds/bumps in the road….? I get the fact the fact that many want to be ruthless with their capital, but is switching horses in the middle of the race productive?

18 Likes

we have to stop micro-scrutinizing numbers. You heard it right. These are COMPANIES we are talking about. Do you think them landing at 13% instead of 15% QoQ growth should entirely change your conviction ? Come on, we function better than that…

Thanks for the nice reminder post Ysdrasill, especially about not micro-analyzing micro-deficits and looking at the whole company, and also about not filling the board with junk one liner posts.
Best,
Saul

54 Likes

Perhaps I can add some value to those who are wondering how to look at the 3 things suggested by Ysdrasill in the context of Quarterly Earnings Announcements

  1. Numbers
  2. Story
  3. Theories

At every Quarterly Earnings announcement our company will give us the following documents to review so we can look at Numbers, Story, Theories(Thesis, Conviction).
To illustrate witht the exmple let’s take a look at ZSCALER (ZS) latest Q2 Earnings (ending JANUARY 31st) after the market close on 2/14/2022 (24 days after Q closing date)

Quarterly Earnings landing page:
https://ir.zscaler.com/financial-information/quarterly-resul…

  1. Press Release document shows us numbers for the ending Q (Quarter), guidance numbers for next Q and for the FY (Full Year), exciting wins during the Q. It’s Earnings at a glance, not the full story yet

ZS Q2
https://ir.zscaler.com/static-files/f50149d3-3a1e-4ad0-b87d-…

  1. We also want to get Supplemental Information document, more numbers showing comparison of previous Qs (last 6 or 8 Quarters), additional metrics for customer growth etc. In that document I look for what has not been included in Press Release.

ZS Supplemntal Info
https://ir.zscaler.com/static-files/4518a7a6-d0de-4b9e-bdb0-…

  1. They may also give us updated Investor Presentation, a graphical presentation slides that highlight what the company does what metrics matter. I look for numbers there that may not be found in Press Release nor in Supplemental Information.

ZS investor presentation
https://ir.zscaler.com/static-files/38a3cc14-35c2-4a48-8538-…

  1. Earnings Call is brokern into 2 parts: Part 1: Prepared Remarks, during Earnings Call, the first 20 minutes, CEO and/or CFO read Prepared Remarks. This Part may have more information about the Story and Numbers not included in previous docs. This document may be supplied separately or part of Earnings Call Transcript. I read it while they read it out loud. it’s a good practice to tie their tone of voice to my understang of the text.

ZS prepared remarks
https://ir.zscaler.com/static-files/7f8561d8-d477-4419-9497-…

  1. Part 2 of Earnings Call is Q&A Session with Analysts: You can listen live (or replay later); CEO and CFO taking questions from Analysts who cover the company. There may be up to 10 analysts asking one or two question. After the call we usually get Earnings Call Transcript document so we can review the call in textual format, and if I listened to the call, I can represence myself to that moment of discussion.

ZS does not have yet a link to Transcript but you can find them usually at either: Fool.com
https://www.fool.com/earnings/call-transcripts/2022/02/24/zs…
(notice fool.com shows Q2 ending Dec 31st 21, which is incorrect, Q2 ended on Jan 31st, not all companies end their Q in DEC)

or at SeekingAlpha.com
https://seekingalpha.com/article/4490244-zscaler-inc-s-zs-ce…

It’s very important to me to listen to the Earnings Call. I want to hear directly from CEO and CFO, I want to hear their tone of voice in reading Prepared Remarks, how they are articulating the company’s quarterly numbers and customer wins. I listent for clarity, conviction, fluency in answering Analyst’s questions. If they start defending or not-really-answering a question then it’s a possible ‘red flag’ moment. Listening to CEO and CFO lets me hear what they are telling me and what they are NOT telling me. They work for me. I want them to assure me things are going great with the Story and I can confirm my Thesis.

Let’s talk about Numbers:

I want to clarify that when I say Numbers I mean numbers for a particular Metric that I am following. Example: Revenue is a Metric, and I look at the numbers for the last 4 to 6 Quarters to see how that Metric is Improving, what the numbers are telling me about that Metric. And overall Numbers means numbers for more than one metric all looked at hollistically.

As was said previously we have to stop micro-scrutinizing numbers. If a company earned 100 Million last Q and this Q they earned 113.74 Million I’ll just round it up to 114 or maybe keep the 113.7. The precision in numbers does not matter to me. I care about the Metric’s direction. If their QoQ was 13.74% I’ll just look at it roughly 14%, again, precision is my enemy in this situation.

Quick Glance at ZS Metrics:

Revenue: 255.6M, 63% YoY (Year on Year) growth, more than last Q growth of 62%

Now I look at what they told us in Q1 outlook, they said they would make 242M max revenue, expecting 5% QoQ, so they beat by 5.6% and grew 11% QoQ. Outstanding.

I quickly glance at the outlook for Revenue they give for Q3: 272M max, expecting 6.4% QoQ growth. Outstanding, better growth. They may beat by 5% (or not) but if they do we may see 287M next Q. But not to worry, play with numbers here, compare how they beat in previous Q.

Now is a good time to say that all other metrics I look at are what’s called NON-GAAP or adjusted numbers (not all). I don’t care about GAAP, those are Accountant’s numbers. I want Adjusted NON-GAAP numbers to tell me the STORY of the business and NOT the Accouting rule by which the business is obligated to report. You can hear that also in Prepared Remarks Earnigs call when CFO says “All numbers unless specifically stated I am going to refer to are NON-GAAP numbers.”

Next 2 metrics to look at are:

Adjusted Gross Profit Margin: in this case 80%, bravo, in line with previous quarters.

Adjusted Income from Operations: They told us last Q they will make 21M, they delivered 22.3M, or 9% margin (% of revenue) and 6% beat.

The purpose of this post is not to explain metric so I will not go into Adjusted NET Income, Cash Flow from Operations or Free Cash Flow (FCF). Find those in the QE (Quarterly Earnings) documents specified above.

In Case of ZSCALER they told us that the one metric they pay attention to see how healthy the busines is to look at BILLINGS. This is a measure of customer’s contracts. They delivered 367.7M in billings, 59% YoY. Some people may not like this number because in previous 3 Qs they delivered 70% growth, but this metric alone will not tell you the whole STORY.

I look at 3 buckets of Operating Expenses: 1) R&D 2) S&M 3) G&A. Usually the biggest is S&M (Sales and Marketing), ZS spent 50% of revenue on Sales, Go-To-Market. $127.2M (see Supplemental Info page 6.), it grew from prev Q which was 48%. They spent $17M more than last Q on Sales. They spoke about hiring more Sales people to go after new customers on the ER call. I expect next Q that number may be higher, if so then it will validate that their strategy is to keep hypergrowth and get more large customers.

A word about that: They mentioned on the call that some customers you can get under 6 months and some larger ones up to 12 months, so to start adding 200 enterprise customers per Q is going to take some investment in Sales and Marketing to go after more of those customers and to shortent the sales cycle if possible. I am ok with that. Let’s double the customers in the next 4 quarters. (may be possible, we’ll see the numbers next Q.)

Speaking of Customers: I move to NON-FINANCIAL metrics that matter to the Story and my Theories: They said they have 5600 paying Customers

Customers paying $100K+ ARR: They have 1751 of those customers who pay over 100K per year in Annual Recurring Revenue, they added 135 customers in the last Q, 8% QoQ, 48% YoY growth

Customers paying $1M+ ARR: 251 customers now pay over 1M per year. They added 27 of those last Q, for 12% QoQ, 85% YoY

Headcount: how is the company growing new developers and sales people. In Prepared Remarks they say:

We added approximately 1,000 employees globally in the last 6 months and have over 4,000 employees

In today’s competitive hiring market, Zscaler is a destination for top talent. We are proud of our Glassdoor rating, which is among the highest in the industry.

And notice on the Q&A session there was a question about that

incredibly impressive to be able to find and hire 1,000 people over the last six months in this environment. But when you kind of think about one of every four Zscaler employees being new to the company, could you just talk about how you’re managing that growth? And also, given the expanded draft of the products and the more multi-polar sales, how we should think about the ramp time for adding new sales headcount

Aha. Story, how is it unfolding by looking at hiring? Read Jay’s and Remo’s answer in the Earnings Call Transcript.

Some highlights:

we are a top destination for top talent. So hiring is obviously the starting point.

make sure these people can be easily incorporated in the company

a very strong enablement team, a number of boot camps for training we do and buddy systems realign. So a number of things are doing to make sure these people are becoming part of it

we’re doing well across the board in hiring

One last point about Billings Q&A session that may shed some light on why:

Question: billings 59% growth at this scale is obviously very impressive. It was a little bit below … the usual seasonality and the 70% type billings growth that you guys were doing over the last four quarters.

Answer from CFO Remo:

59% billings growth, as you mentioned, is absolutely outstanding. If I take a look at Q2 … one area that didn’t perform … it was federal … low single-digit of our new and upsell business

It’s just the budget constraints

…our feeling is, federal will be a substantial portion of our business. We got the FedRAMP certification. Also, we’ve built up a strong team with the relationships.

So, for me the Story is: Get more sales people, close more deals faster, it’s going to cost money, plow it in to grow.

I will not go into more details but reiterate that for 1) Numbers 2)Story 3) Theories our primary source of information is a compnay’s Investor Relations website.

My Duty and Responsibility as an Investor

I am resonsible for my money, nobody else is to blame if my portfolio goes down, and nobody else is to be praised if it goes up. I am the person managing my money.

I have to do the work, I have to read all the documents and make informed decisions. Nobody is going to hand me Numbers on a silver platter. I get all my numbers from Investor Releations, not yahoo, not any other aggregator that promises me to make it simple and fast. There is no fast, there is only slow, one metric at a time. I have to do the work of understanding Metrics, numbers. I don’t expect anybody to do my homework for me.

There are no easy answers: I have to build the Story that makes sense to me in a company I want to invest it: Are they growing, how fast, is the growth durable, are more customers signing up, are customers not sticking aroud, is the Culture solid or toxic, are the funders driving the business, are they transparent or fishy, is the CFO clear about the numbers, the expectations etc…

Without a Story backed by numbers I am flying blind and Volatility of the Market will usually scare me to sell low.

I have incompete information going forward, I invest by conjecture. I may be wrong plenty of times.

When I have incomplete information it’s easy to succumb to here-say, sloppy argument, whataboutitsm, and general malaise, bandwagonism, confirmation bias and other general fallacies. Let’s not do that. Let’s stay focused on Numbers, Story and Thesis.

For every Quarterly Earnings I take about 4 to 6 hours to study the documents I mentioned above and I compare to previous Q, and I review what happend during the Q. I am slow but methodical in my madness. I need to look at All the Numbers All at once and All Story plots how they have been stated and how they are unfolding.

The best way to do this is to do in a low fidelity way in google spreadsheet, really simple boring spreadsheet, and to get intimate with all the numbers and the Story, only then I can think of theories, thesis, convictions.

Doubt is my companion, I am never too sure, too confident, too cocky, I am always ready to change my mind if new facts come to light.

I also read everything I can find of substance on my company

I don’t expect to get results for the work I didn’t do. If I don’t understand something I don’t just demand someone tell me or explain it to me. Nobody on this board is required to fix my ignorance. It’s my ignorance and I have to read, listen and study.

Good luck to all. Let’s stick with Numbers, Story, Thesis etc…

Thank you for reading, hope it was useful.

Let’s not post OFF TOPIC. Back to discussing Company’s Numbers, Story and Thesis, Theories etc…

Baconski

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