How I pick a company to invest in

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

For Knowledgebase for this board,
please go to Post #17774, 17775 and 17776.
We had to post it in three parts this time.

A link to the Knowledgebase is also at the top of the Announcements column
that is on the right side of every page on this board

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I just thought of another factor. Some of my current stocks I moved into because I perceived that they were misunderstood by the market.

Twilio, where growth evaporated because a previous large customer, Uber, decided to take most of their stuff in-house. This masked the 60%+ revenue growth of all the rest of their revenue, which is now being recognized.

Nutanix, which was doing away with pass-through, zero-margin hardware, and moving towards a software-only model. Not counting the hardware made it look as if revenue growth had slowed, while the high-margin subscription software was growing at still rapid rates.

Pivotal, in which the legacy service component was hardly growing, while the high-margin subscription software was growing very rapidly, and is now two thirds of revenue.

Saul

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Best thing I’ve ever read at 5:00 am.

Thanks Saul.

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and as a true / false table


How to pick like Saul

Reccomendation

Revenue growth >35%

Special Niche

Recurring Revenue

High Gross Margin

Dropping losses as % of revenue

Increasing ProffitsIncreasing Gross Margin

Customer Aquisitions

Improving Cash Flow

Dropping OPEX as % of revenue

Dollar-Based retention rate obver 100%

High NPS

Founder Led

A lot of Cash and no debt

Low customer concentration (topp three making up 40% of revenue)

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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.

This is probably underappreciated, and understated, when it comes to applying Saul’s philosophy of a concentrated portfolio.

As a recovering Boglehead, I can attest the most alluring aspect of the Vanguard approach was that I could set it and forget it - saving my time to focus elsewhere. The deep analysis, scrutiny of company news, reports, and customer trends were all discounted - if not discouraged- because you “diversify your risk” by playing into Index or Market funds.

However, you also diversify your rewards.

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Fellow investors,

Saul’s post on “How I pick a company to invest in” is pure gold. I encourage all of you to keep a copy to refer back to from time to time.

I am a an old timer, retired, and grateful for all the years Saul has sacrificially been sharing his insights into his remarkable investing results.

Still learning after all these years,

Jim

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yes and lately that has been found in SaaS which is a sector that emerged and grew tremendously these past years.

of all the talk I think it is simply about getting in the right trend at the right time. SaaS has become an important trend with the advent of cloud computing. And Saul’s reflects that. Just 3 years ago he was in SKX and BOFI. Not anymore. He saw that growing sector and pitched in. All in.

But has the sector matures (not that it has and I think it is going to go on for a while still), SaaS per se may not wow investors as much and it will become a norm.

I would be interested to know what other businesses would exhibit such characteristics.

tj

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Hi Saul,

I was going to post this question to you in a separate thread, but after reading your post here, I think this is the right place.

I have followed this board for a few months now, but haven’t posted on it until now. Also, I read through all of the knowledge base (which is an amazing read for anyone, but settle in for a a while).

My question for you is what is your current perspective on profitability and valuations like PE? From your knowledge base, you speak multiple times in PART I about a “reasonable PE”. Then in PART III you discuss the graphing of your stocks on a weekly basis, and doing this for price and earnings (again discussing PE).

So my question is this: today, your investments all have negative earnings. Have you changed your mind on the importance of profitability and a reasonable PE from years ago when you wrote most of the knowledge base?

I am not trying to pry or say you’re wrong. I am merely seeing a bit of a disconnect in the knowledge base (call it your founding principles) and your current portfolio. The knowledge base appears to include profitability or PE in your criteria, but your current portfolio does not.

I’m guessing that if your investments have all of the things you outline in this thread (rapid revenue growth, moat, recurring revenue, and good $ based retention rates, improving metrics, strong balance sheet, founder-led, not high customer concentrations) that perhaps you are willing to look past lack of profitability. Is there a difference in how you look at a NTNX or AYX (where profitability is still 2+ years out) vs. something like a TWLO/SQ/SHOP that is essentially turning the corner to profitability now or in the near future?

I happily own a few companies that are not profitable (SQ/PVTL/TSLA/SHOP) so it’s not that I am against investing in companies with no earnings. However, I have struggled with some of these companies where profitability is still years away. And after fully reading through the Knowledge Base, I thought it reasonable to ask you to weigh in on this.

Thanks, JMac

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Saul,

Thank you for organizing your thoughts so coherently. Honestly, from someone who works in corporate finance, your criteria is not dissimilar to how venture capitalists and other capital partners structure their investment theses.

Declaring and adjusting investment philosophies is a smart way to drive selection discipline and ultimately optimize ROI.

There are lots of equity/capital partners who pursue SAAS models given the compounding nature of their reliable recurring revenues and the scale those businesses can achieve based on that lower volatility around annual revenues.

I totally agree with others that your summary should be part of an investor’s core reference base!

Thanks again.

Vic

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Absolutely, I already saved a copy as a PDF in my investing folder

Saul:

Thank you for this gem!

Is there any way your post can be addended to the Knowledge Base?

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Best thing I’ve ever read at 5:00 am. Thanks Saul.

I totally agree with others that your summary should be part of an investor’s core reference base!

I already saved a copy as a PDF in my investing folder.

Thank you for this gem! Is there any way your post can be addended to the Knowledge Base?

I’m astounded and touched that this post struck such a chord with people. Thank you all. As you requested I’ll have it added as an addendum to the Knowledgebase.
Saul

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Saul-

You highlight your love of recurring revenue in your posts and knowledge base. Where do you find that info, conference call, 10Q…???

We own the company. Each company has to have an Investor Relations webpage that show financials and past performance.

I believe that is your answer.

John
Grateful Saul Stalker

As others have stated Saul. Thanks for all you have done for us and the knowledge that you freely share. It’s all there. Detailed, yet concise with a human modesty to boot. However, your biggest gift and not something that one can easily teach is the selling or trimming of a Company that has given you some very nice profits(and could still do so but you tend not to look back) but using that cash to invest in what you consider undervalued or totally miss-understood or under-appreciated other stocks that have more room to run and run fast in hopefully the shortest period of time. Not to mention having no emotion whatsoever with past Companies, successful or not and again taking the cash to possibly increase your positions in conviction stocks.

This takes years of experience and a gut instinct. My level out of 10 used to be around a three. Would say its now a 6/7 but still learning. A small example. About one year ago was fairly sure that SMG(Scotts Miracle Gro had a good place in the pot field with their accessories and hydroponics subsidiary Hawthorne. In January this year, I took the loss around $3500.00 and added to NTNX which has paid off substantially.

SMG could well be the future when legislation is passed here and medical and recreational is legal but it could takes years and it was just dead money and a steadily declining stock price. The main point I am making is that I haven’t given this Company one days lost sleep or kicked myself for losing money. I moved on and this I learnt from you and others on this board. Won’t always work out the way you want it to, but this lesson has to come from within.

Best.
Bran.

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Saul,

You have an incredible way of bringing simplicity, but sound logic to investing.

In so many places, investing is filled with so much noise. You bring an amazing sense of calm and clarity.

Seriously can’t thank you and this board enough.

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For me Saul has given a massive sense of timing. For instance, cognex, a stock I bellive will perform well But in 2 years time. Why would I put money in it now, when instead I can put money in it in 1 and a half years and get similar gains?

Same with Disney, I’m sure it will leap significantly when the streaming service hits next year, but why invest in it now, when I can make more gains elsewhere during this time.

Thanks Saul and forum! You are the best!

P.S I no longer think 100k or 1m is out of reach within my life, without creating a personal business!!!

Rags to riches, good luck and keen senses to everyone! Let’s keep crowdsourcing the hell out of the market!

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You highlight your love of recurring revenue in your posts and knowledge base. Where do you find that info, conference call, 10Q…???

Hi JoRoSki,

It’s usually the revenue that’s on subscription so that it’s paid every month or every quarter. I’d suggest taking a look at 44021 and 44023 which may help explain it.

Saul

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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.

Reminds me of a quote from Isaac Newton: “If I have seen further it is by standing on the shoulders of Giants.”

Standing on the shoulders of giants

The metaphor of dwarfs standing on the shoulders of giants (Latin: nanos gigantum humeris insidentes) expresses the meaning of “discovering truth by building on previous discoveries”.[1] This concept has been traced to the 12th century, attributed to Bernard of Chartres. Its most familiar expression in English is by Isaac Newton in 1675: “If I have seen further it is by standing on the shoulders of Giants.”[2]

https://en.wikipedia.org/wiki/Standing_on_the_shoulders_of_g…

It seems to work as well in investing as in astronomy!

Denny Schlesinger

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Hi Saul,

  1. THANK YOU. Just discovering.

  2. Which non-MF writers do you follow besides Bert Hochfeld? I’m surprised you follow very few within MF.

  3. You say some of my current stocks I moved into because I perceived that they were misunderstood by the market. I made the exact same move with Twilio (logic was that Uber was de-risking / diminishing dependence on a 3rd party for a core capability, not abandoning Twilio due to bad product), but I also thought “could I really be so right as a beginning amateur and the smart money so wrong?” so I bought a 1/6 position rather than 1/3 (and never added). Big mistake. Thoughts/advice to avoid repeating that? I’ve since improved, but slowly and I suspect there’s more improvement to be had.

Thank you so much!
Rohit