I start with P/S together with the 1 year revenue growth rate. This is just the start. I also consider GM, customer growth, cashflow, and other factors which are more intangible like competitive advantage. There are a lot of considerations when I decide whether I like company A compared to company B. And which company I prefer can change as their relative stock prices change. I often make adjustments to my allocations based on valuation, remembering that P/S is a factor that needs to be adjusted for things like growth rate, GM, and several other factors.
Hi Chris, You inspired me to think about how I pick a company to invest in. I simply don’t start with P/S.
First, most of my stocks start with a recommendation and write-up by someone I have a lot of confidence in. This could be someone on the board, Bert, Motley Fool, or more rarely a write-up by someone else on Seeking Alpha.
Second, I would want rapid revenue growth. My ideas about that have become inflated in the last couple of years and where I once might have looked for 20% to 25% as very fast growth, I’m now looking for 35% growth, and usually more.
Third, I look for a stock in a special niche, with something special about it. I guess this could be considered a moat. It also could be considered a potential big future.
Tied for Third, I look for recurrent revenue. I want my company to have last year’s revenue repeating this year and building from there, and not a company that has to go out and grow by selling the whole thing over again. God, this is important! It usually means software, and a SaaS model, and NOT selling things. You just can’t keep growing at 40% selling things. And when an economic slowdown hits, people will put off buying a new car, or a new house, but companies won’t tear out the software that keeps their company going. Software also usually means not capital intensive, and it also means high gross margins.
Fifth, I look for rapidly improving metrics like rapidly dropping losses as a percent of revenue, or increasing profits if there are some already, increasing gross margins, customer acquisitions, improving cash flow, dropping operating expenses as a percent of revenue, etc. If some metrics aren’t improving (S&M as a proportion of revenue, etc), because management says they are taking advantage of a greenfield opportunity to gobble up all the recurring revenue customers they can while the getting is good, I generally approve, but want to see those revenues really growing.
Sixth, I’d demand a dollar-based retention rate over 100%. I look for one over 120%, and I’m impressed by one over 130%. A high Net Promoter score is nice too, but there’s no easy way to get that information.
Seventh, It’s been a long time since I’ve been in a company that didn’t have a lot of cash and had a lot of debt. Almost all of my companies are founder led, but I think that’s mostly because they haven’t been around for generations. They also don’t have huge customer concentrations (top three companies making up 30%-40% of revenue). But I don’t seem to have to look for those features, they just come with the territory.
I, like you, constantly monitor these factors and I exit if they seem to have changed for the worse, or if I think I made a mistake in the first place, or if I’ve lost confidence, or if there are new facts. But somehow, EV/S never enters into my consideration.
Perhaps that’s because I don’t sell out of a stock because the stock price has gone up. Ever. That’s not a sufficient reason to me, no matter what it does to the EV/S. If my position has become too big I’ll trim my position around the edges. Again, consider Shopify. The stock price is about six times what it was when I bought it two years ago at $27, up 500%. I’ve trimmed it innumerable times, but it is still one of my largest positions (4th) at 11.5%. If I was watching EV/S, I would have sold out when the stock price went from $27 to $47 in a few months. That’s just not my way of investing. I added in the $40’s. (It’s now $161).
Again, let me reiterate, I do know that a recession is likely to hit us. They always do. No expansion goes forever. I keep cash segregated so that I and my family can get through it comfortably without having to sell stocks at the bottom for cash. I carry no margin, and use no leverage. But I don’t know when the recession will arrive, and I won’t try to guess. I think that the recent chorus of voices saying that a recession is just around the corner possibly means that it is not right around the corner, but what do I really know about that? Nothing.
Best,
Saul
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