High value EV/S stocks; GauchoChris 3/19 update

We have been discussing high value EV/sales stocks. There has been discussion about historical returns from “high value” price to sales ratio stocks. This ratio if you compare across companies seems silly to me. It is almost like saying that every person who weighs 250 pounds is fat. If you are LeBron James are you fat? Maybe if you are 5’2" and 250 pounds you may be fat. My point is that looking only at price to sales ratios can be quite misleading and can lead one to miss great opportunities. One can look at this ratio but there are many other factors to consider.

What is the sales growth rate of the company? A higher growth rate deserves a higher valuation!

What are the gross margins? A company with higher gross margins deserves a higher ratio.

What is the certainty of future revenue? A company with recurring revenue deserves a higher ratio than a company that must constantly acquire new customers.

What is the acceleration of the sales growth rate and for how long will it continue? The recent past shows acceleration, deceleration, or constant growth. Will the trend continue? The future is not written and each investor will have an opinion. Finding company the will maintain high growth rates or accelerate their growth rates will lead to higher valuations in the future (compared to companies that stagnate).

Is the company demonstrating operational leverage leading to higher future profits? A company that will have high profits in the future will have a high valuation. Gross margin is important and maintaining that GM in the future is important. Declining OpEx as a percentage of sales is also important. Some companies are already demonstrating improving operating leverage while others are not. Companies with improving operating leverage deserve a higher valuation.

What is the future runway for the company? What percentage of its target markets has it already captured and how fast is the target market growing. Is it expanding into new, adjacent markets? What is its competitive position. A price to sales ratio does not capture these important aspects that can make a company more valuable because its future duration of growth will be influenced by these factors.

There are other intangible factors that may sway the deserved value up or down.

In my opinion, when someone makes investment and allocation decisions based only or primarily on price to sales ratios that person may be making a suboptimal choice. Saul’s and Bear’s discussion is an example. It has a high ratio. Saul believes it is deserved and Bear believes that it is not deserved. Each looked at some of the other factors besides the ratio. Saul believes that ZS deserves the valuation or even it it is high the future growth will more than compensate for the current valuation. Bear chose to instead put his money in DOCU. I think such a decision and future success includes aspects that are both quantitative and an art.

When I make allocation decisions, I factor in all of the above factors but I don’t do it using a formula…somehow my brain considers them all together and spits out the answer. This is how I arrived at my current allocations which I have changed a bit in the past 2 weeks.

Here’s my current allocations as of the end of Q1 2019:

ALLOCATIONS

So as it stands now, I am down to 8 positions in the portfolio. This is the least number of positions that I’ve had in more than 30 years. I don’t think I’d be confortable with fewer than 8.


        total   stock only    % gain per % gain of stock
AYX	20.3%	20.3%	      1.0%
TWLO	20.1%	15.7%	      1.4%
MDB	16.8%	13.2%	      1.5%
ZS	10.7%	10.7%	      1.0%
SQ	 9.1%	 8.3%	      1.3%
OKTA	 6.8%	 6.8%	      1.0%
TTD	 6.6%	 5.6%	      1.4%
ESTC	 5.4%	 5.4%	      1.0%
options		 9.2%	
Cash	 4.8%	 4.8%	

At present, I am happy with my allocations. The position sizes are pretty much in line with my confidence in the company and how I see that opportunity for future growth. All are companies that I believe have the possibility of rising 10x from here. I also realize that any of them or all of them could by 50%. The revenue growth rates and the recurring revenue that these companies generate give me some comfort that a 50% portfolio decline would be temporary.

The allocation numbers on the left (in bold) are the total allocation including the options positions on the underlying shares. You can see on which companies I own call options by looking at the number on the right. A 1.0% means that I have no call options on the company. A 1.5%, for example, means that I have 1 share equivalent option for every 2 shares that I own.

CHANGES SINCE 3/15/2019

Based on that check-up, I made some adjustments that I mentioned in the same post. In the past 2 weeks, I made some additional adjustments.

I added to ESTC as my confidence in its future growth increased. To fund the purchases I took some from SQ and TTD (mostly SQ).

I sold out of NKTR. I love NKTR and have an emotional attachment to it. I still believe that NKTR-214 (and maybe NKTR-262) will be blockbusters, and all the reasons that I owned it are still intact. So why did I sell out? The main reason is that I think that moving the money into my other stocks will give me better returns and more upside potential. I put the money into ESTC. The more minor reason is that even if NKTR-214 and NKTR-262 are effective treatments there could be other treatments developed by other companies that are even better. When I compare this to these SaaS cloud companies, I don’t see their services/subscriptions being as replaceable.

I was still holding on to some NTNX call options. The dollar value of these options was only 0.2% of my portfolio so I previously figured that leaving it shouldn’t matter much and I could make a big return if NTNX gets their act together. I changed my mind, took the capital loss, and put the money into ESTC. Not a major decision either way.

PORTFOLIO RESULTS

The portfolio continued to grow in March. The portfolio hit a peak on 3/21/2019 at +55.7% YTD. I am now tracking the portfolio on a weekly basis (every Friday) and I’m noting the days on which the portfolio hits a new peak. In 2019, the portfolio hit a new peak on the following days: 2/27 (prior peak was on 9/4/2018), 3/14, 3/18, 3/19, 3/20, and 3/21.


	YTD	MTD	SP500 YTD  SP500 MTD	Delta YTD   Delta MTD
Jan19	26.9%	26.9%	 8.0%	   8.0%	        18.9%	    18.9%
Feb19	39.5%	 9.9%	11.5%	   3.2%	        28.0%	     6.7%
Mar19	48.7%	 6.6%	13.6%	   1.9%	        35.0%	     4.6%

Returns from Options
My portfolio is currently up more YTD than portfolios that have similar allocations in the same stocks. The reason is that I have used options. This weekend I calculated how much of my gains were from just holding the stock and how much of the gains were from options on those same stocks. Here are the results:

Since 1/1/2017, the portfolio has gained 275%. Actually this calculation includes about 25% of the “portfolio’s” value that was tied up in real estate that was not invested until the middle of 2017. The portfolio’s gain since 6/30/2017 was 234% or a CAGR of 99% compared to a CAGR of 80% since 1/1/2017. The reason that I am bringing this up is that I want to calculate how much of the portfolio’s gain has been a result of the options strategy that I started using around the middle of 2017. So the numbers came out as follows.

Portfolio gain since 6/30/2017: +234%
Portfolio gain w/o options since 6/30/2017: 169%
% of the gain from stock only: 72.25%
% of the gain from options: 27.75%

Clearly, the options have contributed significantly to the portfolio’s returns. I was rally surprised that the options contributed this much to my returns. I thought my stock picking was better than it actually was. I had a lot in NVDA and NTNX which ended up reducing my returns (compared to if I had had the funds invested in other companies) even though I still made some money on each: the opportunity cost lowered the returns.

The logic of using some leverage
Leverage cuts both ways. It amplifies gains and losses. I’m using it because I believe that the odds are stacked to the upside. Saul has something like a 27 year track record of 25+% annual gains. On average. There is always the possibility of a down year or even a protracted time period where stocks go down and stay down for a long time. Leverage adds the possibility of bigger losses in down years. However, given that the average will stay +25% per year using some leverage is a mathematical no-brainer for me.

Chris

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Hi Chris,

Thanks for sharing your portfolio information and congrats on some recent good returns!

I have to say, you lost me on this (I can be pretty dense, so forgive me):

The logic of using some leverage

Leverage cuts both ways. It amplifies gains and losses. I’m using it because I believe that the odds are stacked to the upside. Saul has something like a 27 year track record of 25+% annual gains. On average. There is always the possibility of a down year or even a protracted time period where stocks go down and stay down for a long time. Leverage adds the possibility of bigger losses in down years. However, given that the average will stay +25% per year using some leverage is a mathematical no-brainer for me.

My question: so the logic is:

Over the last 27 years, Saul has achieved 25+% annual returns (on average);
You invest just like Saul, so you will earn, 25+% annual returns (on average);
Egro, the odds are stacked to the upside, so using leverage is a no-brainer.

Did I get that right? Or did you mean something else here?

Best, Swift…

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