Focusing on what we're good at

We have an exceptional board and community here. We’ve been able to identify REALLY exceptional companies and have had success most people would have thought (and may still think) incredible. But I don’t think we’ve proved any ability to divine when a recession will come, or what will happen to our stocks when it does come. We can try to extrapolate from good days or mini-pullbacks. But in reality, we just don’t know.

It’s a bit frustrating to see so many posts regarding what will happen to SaaS stocks in a recession. Yes we know that these companies can actually save their customers money. We know that their services seem essential to their customers’ success. But we also know that these statements are not exclusive to SaaS companies. All great companies strive to add value for customers! And many succeeded long before SaaS in adding to customers’ offerings, and making themselves indispensible.

But that’s fine. We all know that investing has ups and downs. None of us think we, or Saas, is immune to this. So let’s move on! Instead of discussing things which we don’t know, I’d love to see us focusing on individual companies. One question I’ve been pondering is:

Which companies could plausibly grow revenue 50%+ for the next 3 to 5 years?

My first thought was, almost none. Even for businesses like Twilio that have been growing at 50%+ (really more like 70%+) for a few years, things as they are now will work against TWLO going forward.

  1. Scale becomes a problem. Twilio will have well over 1b in revenue this year, so with a 50%+ pace that would mean $8 billion in revenue in 5 years. It just doesn’t pass the smell test to me. It took Salesforce more like a decade to go from 1B to 8B (https://www.statista.com/statistics/211587/total-revenue-of-…), and we know intuitively that revenue is more difficult to grow as speedily as it scales.

  2. Just a couple quarters ago, Twilio had a pretty big acquisition (Sendgrid). This is great for total revenue in 2019. But the acquired company is growing a lot more slowly than Twilio, so this will put a drag on overall growth of the combined company after 2019, unless they can find - and I almost hate to type this word - synergies.

My second thought was, well, wait a minute. Some of our companies still have 1/3 or 1/4 as much revenue as Twilio does. AYX, SMAR, ESTC, PLAN, ZS, MDB and others all have TTM revenue of about 300m or less. So scale might not become a problem for 2 or 3 years. And smart future acquisitions might actually help their stocks (as Sendgrid seems to be helping TWLO in 2019).

I throw it to you: which companies do you think can grow the fastest for the longest? (Obviously I’m not looking for guesses only, but for reasoning and data that justifies the answer.)

Bear

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I throw it to you: which companies do you think can grow the fastest for the longest? (Obviously I’m not looking for guesses only, but for reasoning and data that justifies the answer.)

It is always a good question to ask. We can look to maintained growth each quarter and to management commentary on the earnings calls. We should also continue to look at TAM for each company, confirmation of TAM, increases to TAM, and of course TAM compared to market share already captured by the company and by competitors…and uncaptured greenfield.

Putting the above together we can see an evolving picture for each company and we can make the necessary portfolio adjustments each time we get new info.

Chris

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We should also continue to look at TAM for each company, confirmation of TAM, increases to TAM, and of course TAM compared to market share already captured by the company and by competitors…and uncaptured greenfield.

But how do we figure in new solutions in new areas that our companies like Okta, for instance, keep adding, which enlarge their TAM… or like IoT which came out of the blue for Twilio yesterday (see post above).

It seems very hard to predict.

Saul

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But how do we figure in new solutions in new areas that our companies like Okta, for instance, keep adding, which enlarge their TAM… or like IoT which came out of the blue for Twilio yesterday (see post above).

It seems very hard to predict.

We can see that some companies like TWLO and OKTA have in the past demonstrated product extensions and entirely new forays. I give these companies credit for this and tend to think they will probably come up with more in the future. It’s another reason to stay invested in them.

Chris

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Chris: We can look to maintained growth each quarter and to management commentary on the earnings calls. We should also continue to look at TAM for each company, confirmation of TAM, increases to TAM, and of course TAM compared to market share already captured by the company and by competitors…and uncaptured greenfield.

This is exactly on the lines of what I was thinking. Maybe raw revenue numbers aren’t as helpful as percentage of TAM. I tend to favor the former, since I’m skeptical of TAM estimates.

As for maintained growth, I agree there as well. Current growth rate gives us insight into so many things. Qualitative factors. Competition. Opportunity for optionality. When a company’s product seems compelling but revenue isn’t growing ultra-fast, we rightly ask why. Perhaps the customers know more than we do…or maybe (I’m searching for good examples…ZS?) they just haven’t fully caught on and revenue will accelerate.

Saul: But how do we figure in new solutions in new areas that our companies like Okta, for instance, keep adding, which enlarge their TAM

Chris: We can see that some companies like TWLO and OKTA have in the past demonstrated product extensions and entirely new forays. I give these companies credit for this and tend to think they will probably come up with more in the future.

I like optionality as much as the next guy, but a company can’t keep re-inventing itself forever. I tend to believe these types of things (see Mongo’s Atlas) are much more effective at a 200m or 300m revenue run rate than a 1B+ run rate (see NTNX). At some point, “new solutions” will be incremental more than company-altering or game-changing. Unless of course you invent the next iPhone. But one of the things we actually like about our companies is their predictability. We want to see incremental good change like you guys mention, but the larger overall revenue is, the less “new solutions” will move the needle. SQ is a good example – their subscripton services have kept them growing fast for a long time, but I think in the next year or so we’ll see overall growth slow below 50%.

So yes, I believe TWLO (or OKTA…I’m less bullish on the optionality there) can definitely grow into many billion dollars of annual revenue. I just don’t think they’ll be growing it 50%+ three or five or ten years from now.

For MDB, the story seems to be that they have a lot of green field ahead even with their current solutions. If we see Atlas slowing more than Ethan and I discussed, that could be a problem. (https://discussion.fool.com/mdb-specifics-for-tinker-34241975.as…) But perhaps it could grow even faster…

Something to watch. If we can see trends like that developing, I believe that’s the kind of thing we should be looking for. I don’t see it now, but you can bet I’ll be watching. (I did add a small MDB position back this month, though, just in case.)

Bear

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But how do we figure in new solutions in new areas that our companies like Okta, for instance, keep adding, which enlarge their TAM… or like IoT which came out of the blue for Twilio yesterday (see post above).

It seems very hard to predict.

Somehow, it seems like there are a lot of story stocks on the table. However, given the signs of impending and already happening change in the way we deal with production, ressource management, regulation of flow of goods, value and people, I think it’s qzite safe to say, the “story” is comparable with the beginning of the industrialisation. But it will happen much quicker.

AI and IoT still have that smell of “yeah, sounds interesting, but…”. Yet, when I follow the changes in the way AI and robotics changes medicine, how telemedicine and wearables grow closer, how IoT and Smart initiatives really start to happen right now, when I see how these real world changes accelerate (just like Saul’s post shows for TWLO), the story seems at least very, very plausible. So I guess, innovative and well managed companies might have that pole position to grow incredibly in the coming few years. Much faster than industrial companies did at the start of the industrialisation, simply because it takes less hardware and brick and mortar facilities to make things happen.

We’re not talking about old wine in new bottles. We’re talking about completely new products and services that can’t be directly compared to the way companies improved slightly/sequentially over well know old products and services.

So far, the “Saul stocks” and a few interesting picks from RB and SA seem to be very well positioned in that starting race. I try to judge the position and initiatives of stocks in respect of them to be able to drive the revolution that happens right now. This also means, I cannot simply compare them to e.g. IBM, CSCO, GM etc. Who shows more than just a story? Who is really delivering technology/services that have the potential to power the new revolution? If they do, I am willing to accept high valuations.

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Hi all,
Bear I am not sure I can add much to the estimate discussion but I do think you have hit the nail on the head. Predicting, or at least staying ahead of the revenue growth question while watching to make sure that a progression towards earnings continues is the key in my opinion.

I haven’t weighed in on the valuation discussions (because there has been plenty of weighing!) but I think the “crazy high” valuations will continue as long as the growth does. Saul, you wrote a very thoughtful set of assumptions/logic and asked anyone to challenge them. Nobody really did. I thought about it and realized that your logic was sound. The only hole in the logic is assuming the growth will continue, and that is not really a hole, just a discriminator of when the logic will break down.

I recall a quote from Warren Buffett that said essentially that there is no price that is too high for a company that will grow 30% forever. Due to the magic of compounding it will eventually become cheap from any price. Not too dissimilar to the old “start with a penny and double it every day and see how quickly it becomes an incredibly high number” story. Of course the reality check to those thought experiments is that they can’t grow that fast forever.

Back to the question at hand. I think the reason the markets have reacted so poorly to low guidance from our SAAS companies is exactly what I am postulating here. Any sign that the growth is slowing is going to cause a price drop. Even when the guidance has always been low, the market reacts, and the hedge fund / traders decide I better get out before everyone else.

So guidance doesn’t work. So how do we determine growth rates going forward? that is the million dollar question. Staying with the smaller total revenue companies seems like it would make the job easier, but no guarantees. A comparison to the actual TAM is perfect but now there are two numbers we have to predict and track, growth and TAM. The job just got harder.

It seems that Saul’s historical method of watching quarterly numbers like a hawk and reacting to anything that might suggest slowing may be the best answer, but even then you may not be quick enough. My fear is the markets might be pretty quick with this whole group if a belief of slowing spreads…

Having said that I don’t have any better answers. A growth in potential TAM is good. Continued and accelerating revenue growth is good. Increasing margins and bottom line earnings is good. As long as they continue, stay the course. If they waiver… always know where the door is…:slight_smile:

Randy
Long “SAAS stocks” to the tune of about 25% at the moment… I can’t bring myself to go farther than than with my life savings…

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For investors who are relatively nimble as most on the board are, I have figured out that it’s just not worth the time and effort to try to predict how companies will be doing 5 years from now. You simply can’t know with any degree of certainty. Sure, you want companies that seem to have a reasonable chance of continued growth but it’s far easier to just invest while the company is growing and make decisions as new information becomes available. If/when OKTA or TWLO or MDB show signs of slowing growth, you decide whether it warrants selling. You might give up 15% but will likely have gained far more by staying invested rather than getting out a few quarters early because you think their growth will slow.

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Bear,
I’ve been a follower and occasional poster on this board practically since it began. The participation on this board has outgrown my ability to keep up with everything that gets posted. I have to pick and chose which threads I will follow, which posts I actually read. I tend to read most of yours.

With all due respect, I think you are asking the wrong question. From my perspective, the questions I ask myself every quarter are: “Given the growth and other factors being what they are, do I still have high confidence in the stocks I currently hold?” “Are there investment opportunities that I believe are better positioned for future stock price appreciation than what I own today?” “Do any of my holdings appear to be nearing market saturation?” “Are the products offered by the companies I own still ‘category crushers’ with little or no robust competition?” “Are the products offered by the companies I own virtual business imperatives with respect to the emerging information economy?” You get the drift I hope. It may not be these exact questions (to be honest, this is the first time I’ve written them down), but questions of this sort. If 50% growth cannot be sustained are there better investments? I don’t just look for growth, to me the actual business is vitally important. We’ve all rehashed the dot com bust when many stocks were growing at an incredible pace, while many of the companies hadn’t even fielded a product. Note, I said “stocks,” not “companies.”

We are fortunate to be witnessing and participating in the very early stages of the information economy. Just as the industrial age before it did not eliminate agrarian society. There remained a need for farm products, there is still a need for farm products. The information economy will not eliminate the need for tangible, capital intensive industrial products. Until teleportation becomes a reality (not in my life time, if ever) people will still need to get from point A to point B. Airplanes, cars, boats and trains (in all their variant forms) are not going away. Craig McCaw didn’t herald the elimination of the phone, he simply removed the wire. Steve Jobs didn’t herald the elimination of the cellular phone, he simply made it a component of a pocket sized general purpose computer.

What I’m driving at is that the innovations that come along with new economic frontiers do not eliminate the needs that gave rise to the economic era that preceded it. But they do tend to commoditize those products. Maybe that would be better put by observing that the products of the former era have reached maturity. At the dawn of the industrial age, steel was not a commodity. Even though steel production was not proprietary, the early entrants ruled the market for quite some time before would be competitors could raise sufficient capital to put a dent in the market leaders’ revenue. As Denny has pointed out numerous times, all innovations are subject to the S-curve. There always comes a time when saturation balances with new and replacement demand. At this point branding and price are the primary forces of competition.

When I first joined this board we were looking at sneakers, chips, network h/w and the like. Industrial age tangible products supported by a large consumer or b2b demand. There was talk of the information economy, but it was difficult to identify companies and products that were participants in it. That is no longer true. We are fortunate enough to be present at a time when the internet, cloud computing and other forces have coalesced in such a way as to permanently alter the economic landscape.

The companies we are invested in have products that fill an imperative demand. My view is that the s/w products and support services offered by these companies are indispensable, primarily in the b2b space. While capital is still a necessary component for the success of any business, the new economic paradigm is more dependent on intellectual properties. Capital itself has become a commodity.

While I look at growth as a primary indicator of best of breed investments, I also look at what are the goods and services. Where do they reside on the S-curve? Do they fill a crucial demand? When taken in combination with the management and business model, are they category crushers (without significant competition)?

How does this play out with my investment decisions?

MDB - The database of the information economy. Primary competition are legacy relational DBMSs. I could wax long on this. Relational will be with us for years to come, but as I often admonished my IT colleagues, there’s not an end user in the world who cares how their information is tucked away on some server somewhere. There’s not an end user in the world who cares if their information assets are stored in rows and columns or as an integrated special purpose file. It’s completely irrelevant. And as parsers, and AI functions such as recognition of real world objects and events, i.e., facial recognition, vehicle guidance, speech to text and text to speech, sensor speed, diversity and reliability, IoT, 5G, etc become ubiquitous I wonder if the relational storage model can be sustained.

ZS - The network security vendor of the information economy. Primary competition are numerous legacy h/w components with s/w controllers. The legacy environment is costly, difficult to maintain, every new component (including product upgrades) presents potential compatibility problems and requires a large effort in regression testing and the entire kluge inhibits performance.

OK, I’m not going to go through each company, I’ll just assert that AYX, OKTA, TTD and TWLO are pretty much in the same class for substantially the same reasons. I am less confident about SMAR, SQ and ZM (which rounds out my current holdings with the exception of IIPR, an infrastructure company supporting the marijuana industry). I have lower confidence in some of my holdings because I don’t see a strong moat, significant barriers to entry or high transition costs for their customers. You might note the omission of ESTC. I sold my small position as I can’t really figure out what they do, I’m not sure whether they have a moat or not and like Saul I have some misgivings about their business model. I just felt more comfortable without ESTC in my portfolio.

Does this mean I have finally abdicated to the long term buy & hold Fool mantra? No, not entirely, but I am always measuring new investment opportunities against what I believe to be the potential and performance of my current holdings. Would I jettison MDB for a poor quarter? Doubtful.

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guidance doesn’t work
we should not assume that corporate management knows the future. In fact they may not be able to do much more than make a semi- informed guess. They can be so blinded by the trees of their own business that they do not see the forest of the sector or the overall economy. Or like the CEO of Nvidia, see the trees but not understand what is happening.
Personally unless there is some clear news, I just follow the numbers. Even if you are blind sided it usually takes some time for the full stock effect to be felt.

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I don’t pay attention to corporate guidance. I do pay attention to how management manages and communicates. I got of BOFI because of I felt CEO Garrabrantz was incompetent. I got out of PVTL because of a disastrous quarterly review during which CEO Mee just verbally wandered at length. I got out of NTNX because I no longer had confidence in the CEO Pandy. My confidence is increased when I hear management provide coherent, insightful reasons for performance, budget allocation and direction.

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the questions I ask myself every quarter are: “Given the growth and other factors being what they are, do I still have high confidence in the stocks I currently hold?” “Are there investment opportunities that I believe are better positioned for future stock price appreciation than what I own today?” “Do any of my holdings appear to be nearing market saturation?” “Are the products offered by the companies I own still ‘category crushers’ with little or no robust competition?” “Are the products offered by the companies I own virtual business imperatives with respect to the emerging information economy?” You get the drift I hope.

Brittlerock, the above is just a little bit of your post, but I thought the whole post was one of the most useful and insightful posts I’ve read in a long time! Thanks so much for posting it. I wish I could rec it several times.

best,

Saul

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Below is a link to an article I believe every member of this board will find useful. I have to think it has already been posted here because it is so relevant but a search for “grow fast or die slow Saul’s site:fool.com” did not yield any hits (for me).

https://www.mckinsey.com/industries/high-tech/our-insights/g…

The article does not directly address your question “Which companies do you think can grow the fastest for the longest?”.

Instead, it provides justification for why your question is THE most important question to ask. The article summarizes research findings from a study of 3,000 software and online-services companies conducted by McKinsey aimed at understanding the factors that predict sustained growth rates (i.e. your question). A few of the most relevant findings are outlined below (all of this is specific to software companies):

  • Revenue growth is the best predictor of future growth and also shareholder returns
  • Software companies with 2-year revenue CAGR >60% when they hit 100 MM in revenue (“Supergrowers”) were 8x more likely to reach 1 BB in revenue than those growing <20% at 100 MM
  • Improvements to cost structure and return on invested capital are not nearly as important (no correlation was found between cost structure and growth rates)
  • Software companies with 2-year revenue CAGR <20% produced on average -10% to -18% in returns for shareholders (not sure if 10-18% is a CAGR or total return over some time frame)
  • 85% of “Supergrowers” were unable to maintain their high growth rates (defined as >40% once they reached 1BB in annual revenue) and once lost, less than one quarter were able to recapture them (and even if they did, they went on to create less shareholder value than companies who maintained consistent growth, which are extremely few e.g. Amazon, Tencent, Saleforce, Adobe)
  • Supergrowers generated 5x the shareholder returns then “growers” (where growers are defined as two-year revenue CAGR between 20% and 60% at 100 MM and between 10 and 40% at 1 BB)

Much of this rings true to the lessons in The Knowledgebase, and the methods used here (e.g. cut bait if revenue growth drops below 40% or so).

There are a ton of other goodies, and some more nuance so make sure to read the article. One section with particular relevance to this thread is titled “There is a recipe for sustained growth”:

  • Sustained growth happens in three stages: prelude, act one, act two
  • Growth in act one is driven by five factors: market, monetization model, rapid adoption, stealth, and incentives
  • Growth in act two is driven by different factors than act one, namely an expansion to new geographies or channels, new product markets, or transforming into a platform

One criticism I will offer is that the findings are backward-looking. If sustained growth is dependent on a successful transition from act one to act two, what good does that do us as we sit watching while act one unfolds? Maybe the takeaway is that the best approach to answering Bear’s question is to collectively put our heads together on each company and ask the question: Does this company have an act two? Or do we cut bait once we think act one is nearing completion? Based on the probabilities outlined in the article, I think the answer is “cut bait”, as is often espoused on this board. Nonetheless it may be worth quantifying each company in terms of the metrics used in this article to see how they stack up and potentially gain some insight into whether we think the company will have sustained growth (something I will work on).

Finally, some of the discussion on this thread is aimed at debating whether we should focus squarely on the growth rates or try to discriminate qualitative factors that might drive sustained growth. The findings in the article seems to imply that the growth rate itself may provide that insight.

https://www.mckinsey.com/industries/high-tech/our-insights/g…

Guy

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Great catch on that article.
Only thought i jad was that it is tough to sometimes get data on what our companies growth rates were like as they were nearing $100m, as they often IPOd after that point.

But i imagine most/all of Saul’s stocks qualify…meaning their liklihood to hit $1b in revenues is stronger than others growing slower.

I thought this was key:
“85% of “Supergrowers” were unable to maintain their high growth rates (defined as >40% once they reached 1BB in annual revenue) and once lost, less than one quarter were able to recapture them (and even if they did, they went on to create less shareholder value than companies who maintained consistent growth, which are extremely few e.g. Amazon, Tencent, Saleforce, Adobe)”

Not sure it changes anything as most here are vigilantly watching eeach ER and are going to be aware the minute growth slows materially.

It seems like perhaps the leash is even shorter after $1b in revenue, as a bounceback from a dip in growth becomes more and more unlikely at that size.

No idea how reputable or thorough the study is, but it does provide an additional data point of comfort to ride the hypergrowth stocks deapite valuations.

Dreamer

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Agreed on the bullet point you highlighted. I also thought this one was particularly relevant:

  • Supergrowers generated 5x the shareholder returns than “growers” (where growers are defined as two-year revenue CAGR between 20% and 60% at 100 MM and between 10 and 40% at 1 BB)

Further support for developing amnesia every time you check your portfolio and simply investing in the best (growth rates).

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I think it was Bert that said something recently that applies to many and most of the companies we follow into this information economy as Brittlerock so eloquently described it. It was such a simple but profound observation I’m adding it to my permanent in my head knowledgebase.

He said something along the lines of “you simply can’t effectively calculate the TAM and market for a company that sells to developers. And that whatever you or the market come up with one day will be completely irrelevant the next as developers develop.” And thus for these types of companies hyper growth has longevity.

I meant this to be for the recent Elastic business model thread but actually found it might fit here better.

ESTC, MDB, TWLO, OKTA, SMAR, WORK, ZM, PLAN, SHOP, and others I’m surely missing in our universe all open source their products to varying degrees and in varying ways to make room for developers to develop.

So in the Elastic case. The question gets asked constantly well what’s their TAM? Or I can’t find what they dominate at. The same piece of software that is used to ingest, datastore, search, and deliver results does the following. Finds the correct driver for an Uber (and Lyft request), gives the best results for your Tinder swipes, knows what product you want at Dell.com, gets Shopify customers the best help for their e-commerce store, secures the ORNL Summit worlds fastest supercomputer, checks financial transactions for fraud for some of the world’s largest banks, is used to detect inappropriate resource usage at AWS. The list goes on and on. They added 900 paying customers last quarter.

How in the world can we realistically categorize a TAM for that? Data store search. First paid proprietary product was launched in 2014 or 2015 and Elastic Cloud Enterprise launched in 2017. 450 million plus downloads. To developers to develop.

You could say this about those other companies too. It’s a new economy indeed.

Darth

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