I need some help and advice re some of my stocks

Hi, Saul-
I am delighted to see that we have an identical top 6 list: TWLO, ZS, AYX, TTD, OKTA and ESTC. I have learned a great deal from your posts sharing your investing thesis and your monthly portfolio summaries. Thank you!

Among the other three DOCU, ZUO and COUP, I thought about getting into DOCU for a while. But I have changed my mind after the NTNX disappointment: why risking your money in the ones you are less comfortable with? Have you thought about waiting for a few months for a candidate from new IPOs? SALCK is going public soon. It appears a good one to keep an eye on.

I am also searching for the 7th great-one. I currently have a large position in ANET, which is not a SAAS and does not carry as high conviction as the top 6. But from an investment point of view, I think it is equally good as the other three (DOCU, ZUO, and COUP), if not a little better.

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Here is another reason why I like ZEN.

ZEN vs OKTA

Both are valued about the same, $8.4 B marketcap.

TTM revenue

ZEN $599 M
OKTA $399 M

companies are valued the same with ZEN having 50% more revenue.

growth rates last quarter

ZEN 41% and accelerating
OKTA 50% and decelerating

Just one quarter, but its possible they have the same growth rate with in a year.

(I think most likely OKTA is still growing faster, but possible)

I like both, and was happy to add to OKTA friday morning on the dip, but if I has to pick which one to outperform for 3 years, I’m probably picking ZEN.

Jim

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Most of these SaaS and even high Price/Sales stocks seem to move as a group. At least in the last year or more . So absent some unexpected but important news (usually found only at earnings or in a buy out), they act like a sector. Even if there is no official name for it.

So I wonder how much you decrease risk by buying more than a few of them. Especially if the biggest risk is a general market decline, second biggest risk sector decline. We saw what the hic-cup ending late last year did to all of them.

Theory says there is individual stock risk, sector risk , and general market risk. Considering the type of stocks we hold ,whether it is 5 or 10, most of these risks are identical . Always it means increased Beta. We can only suspect and hope that it means increased Alpha.

So the number of stocks you own is a personal choice, except for bad news events it may not matter much within the broad range of 6 to 12.

With a 17% holding it is unlikely that you will lose more than half that overnight before you have time to sell. So could the real risk be closer to 8.5%? If you define “risk” as losing money.

I have always owned a small number of stocks .Mostly because of the limited number of super good ideas. To reduce sector risk I also owned index ETF… But for the last several years in has been all stocks , usually 8 to 12 in number.

total confidence in the other 6 I never have total confidence in anything related to equities.

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Great dialogue here.

Saul, I applaud your humility and community approach… you are asking for inputs where as most of us here are constantly looking to learn from you.

On the names you mentioned:
DOCU is solid company IMO… but certainly hard to expect acceleration.
I hold a mid size position…

COUP: I have invested in the past in Concur before they were acquired by Amex (or SAP? I forget)… and another company like this in spend management… both times the top line hit the ceiling too soon in my opinion… i.e. growth rate slow down and never re-accelerated… so there is great network effect here but just not as exciting compared to few others.

ZUO: Others have pointed out services business. I have marked this up to reveiew second half of this year by when hopefully their low margin services have built up some acceleration to their subscription business.

Over last few weeks, SMAR looks more and more interesting to me. Someone posted link to StockNovice’s excellent post. I dont have much to add to that. I am yet to pull a trigger, its more about why get out of what I already own.

I do have large position in MDB, mid size in SHOP and SQ - but you know these names.

One other name to consider is ROKU.
ROKU is up from $27 around X’mas time (at the recent bottom of the market) to ~$70 currently.

They were known as selling those small, low cost boxes to get streaming TV… which was very low margin business… however, they use this as entry into streaming TV and sometime back, they transformed into platform business… meaning they license OS for streaming TV to TCL and others and become gateway to all streaming on your tv when… they offer free / ad supported ROKU channel and also support other popular streaming services… e.g. NFLX, HULU, SLING, ESPN, HBO…

So they transformed from low margin HW business to high margin platform licensing, streaming gateway, paid media & advertisement business based on ROKU platform.
At around 27M US households, they have pretty good size to sustain recurring business and growing. They would be one of the provider of CTV ad inventory to people like TTD. They benefit from the CTV trend as TTD.

Here are some numbers:


	Quarter ending	2017-03	2017-06	2017-09	2017-12	TTM
	Revenue $M	$100.1	$99.6	$124.5	$188.2	$512.4
	Growth Y/Y %			40%	28%	117%
	Growth Q/Q %	-32.0%	-0.5%	25.0%	51.2%	
	Gross margin %	39%	38%	40%	39%	39%
	Free cashflow$M	$24.7	$1.0	-$1.1	$3.5	$28.1
						
	Quarter ending	2018-03	2018-06	2018-09	2018-12	TTM
	Revenue $M	$136.6	$156.8	$173.4	$278.7	$745.5
	Growth Y/Y %	36%	57%	39%	48%	45%
	Growth Q/Q %	-27.4%	14.8%	10.6%	60.7%	
	Gross margin %	46%	50%	46%	40%	45%
	Free cashflow$M	-$18.0	-$2.5	-$2.1	$17.8	-$4.8

Of the $278.7M revenue in latest quarters, platform revenue is $155M and growing between 130% to 80% y/y every quarter for last five quarters.

I feel topline y/y growth rate will be in 40s% at a minimum throughout this year and quite possibly increase depending on how the market evolves.

Surely it doesnt compare to SAAS companies… much lower gross margin… its consumer media company… but fairly unique and provides some diversification to me. To me they employ same tactics or layer growth and also leveraging consumer’s usage of the platform that I am paying more attention to lately.

I have been building a mid size (4%) position in ROKU with average cost basis of $47 (50% gain so far this year).

hope this helps

nilvest

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Saul,
Excellent post that has generated a discussion. To your question, I hold a 3% position on Docu. The stock is priced for 35% growth which the esig business should help generate by its own for a while if you trust the surveys. The company is betting on the SOA and if it can make inroads the growth can edge into the 40% and stock should appreciate a lot more.

Question for those interested in SMAR. I see a couple of issues raised in earlier posts

  1. 7% annual customer growth
  2. 10% customer churn - if true this is a huge negative
  3. Concerns that this is not an essential but good to have product

Any insight on the above is appreciated.

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Personally i dont like those 4 that much.

I like your top 6 very much…i am in all but estc and okta right now.

I would say look at SMAR…they report this week and are coming off 50%+ y/y growth last Q…so moreakin to your top 6.

Maybe apply a chunk of your port to more of your legacy stock qualifications of focusing on P/E until newer SaaS candidates become obvious.

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I simply can’t get behind SMAR. They’re growing fast, but off of such a tiny base. Most other companies aren’t public when they have 50 million in revenue a quarter so I’d guess they were growing much faster when their revenue was that light.

I’m a project manager at a firm with around 5,000 people. Not massive, but I’ve never spoken to someone personally who has used Smart Sheets.

I’ve also never seen any clients use it.

Obviously, they have some customers, but there many other project management products that are much more popular. Maybe that’s SMAR’s opportunity, but I can’t see them getting the kind of saturation they need to grow long term.

Also, I’ve seen a little more scrutiny put on spending from businesses. Not cutting necessarily, just being much more cautious and making sure spending goes towards highest priorities.

That normally is not trying to transition to a new, not well known project management software when there’s known great options.

I could be way wrong, but I’m on the sidelines with SMAR.

Also lots of spend on marketing. Look at one of their popular competitors, much less spent on sales and marketing.

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Saul, I also have 10 stocks in my port. My top 5 have by far the largest percentage. Some are the same as yours, some are not.

I own DocuSign, about 4.8% position. My reasons for owning are as follows:

It may not be the fastest grower but I believe it will be a consistent grower for some time. An example of why I believe in the consistency of growth is the recent announcement of “DocuSign for Salesforce Essentials”. This type of i9nclusion in one of the dominant SAAS companies will help facilitate that growth. I like consistent growers.

Management seems trust worthy regarding growth, they do not seem to over hype opportunities. Still licking my wounds from NTNX and NVDA.

I am not sure of the estimated TAM for the e-signature market but it has to be substantial. I see DocuSign everywhere. It is almost becoming an acronym for the industry.

Profitability is in the not to distant future. Expectations are for profitability in late 2019/early 2020. Some faster growers cannot show me a path to profitability.

DOCU has positive operating cash flow of $74 million, I do need to see positive free cash flow by the end of 4th qtr or I may reassess my position.

They have twice as much cash as debt ( I prefer debt free but using cash to grow is important)

Their EV/R 13.21 is in that sweet spot defined on NPI where best stock value appreciation seems to occur.

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Saul,

I understand your desire to own the fastest growing companies but the question has to be “at what cost”?

The fastest growing companies in your portfolio are currently trading above 20 times P/S, so much of the future growth is already baked in their current valuation.

Docusign is growing in the mid-30s and its P/S multiple is 13 and Zuora is also growing in mid-30s and its P/S multiple is 11; so these ‘slow’ growers are currently trading at roughly HALF the valuation of your top six.

In the future, when the growth rates of your top six come down to mid-30s, then their valuations will also be cut in half (i.e. the stock will lose 50% of its value due to multiple compression). Very easy for a 22 or 24 P/S multiple stock to come down to 11-12 P/S; whereas I doubt very much that Docusign’s or Zuora’s multiple will get cut in half to 5-5.5 times sales.

I’ve crunched some numbers and assuming a 5% growth slowdown in both categories of stocks each year (fastest growers and slow growers) and an end point valuation of around 8 times sales for each company; at current valuations, Docusign and Zuora offer higher reward with much lower risk (less potential valuation compression).

Docusign should continue to grow at the current growth rate for years and Zuora’s management has said that it will maintain 25-30% revenue CAGR for a very long time and given their valuations, these offer better r/r in my opinion but you know best.

FYI - In the Saas space, I’m currently long DOCU, ESTC, SHOP and ZUO (a few weeks ago, I sold TWLO and booked my gains to invest in TME)

My two cents.

Best,

GM

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In addition to some of those those familiar here, I have tiny positions in Atlassian (TEAM), ServiceNow (NOW)and Workday (WDAY). As they look to be doing well enough against IGV, I am too lazy, or busy, to look at their latest credentials. However, these companies are well invested in by fund managers and may be over-priced as a result.

I am not so sure Saul’s lower-weighted positions may not be helpful in terms of diversification. I do share Paul B’s view that price enters into the evaluation as well as quality. Saul achieves improved prices by early identification and then shrewd and courageous trading founded on conviction. Those of us less active in the market must take a view, as GrowthMonkey surmises above. Our Saas companies may be better-founded than most for market doldrums but multiple erosion is a possibility.

It would be interesting to know Saas companies’ PS ratios taken over by the giants in the last two years. I presume when IP value is very high (eg PS values over 20) the temptation to develop in-house must exist; anyone know what the law on IP (like patent protection) is? At what point do MSFT, AWS/AMZN, ADBE and CRM say the company is too expensive to buy?

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I could be way wrong, but I’m on the sidelines with SMAR.

Also lots of spend on marketing. Look at one of their popular competitors, much less spent on sales and marketing.

Tech people often have blinders, I’m speaking from personal experience having started my professional career as an IBM programmer. Surely you know that the Intel x86 is a piece of crap with all it’s limitations. I was sure the Motorola 680x0 was vasty superior. But both the IBM PowerPC and the 680x0 lost the marketing war to the inferior x86. That’s an important lesson for high tech investors and it has been stressed by both Geoffrey Moore, a Silicon Valley marketing consultant, author of The Gorilla Game and by Brian Arthur, professor of economics who did a lot of work with the Science of Complexity. To sum it up, in increasing returns markets there is not just a single point of equilibrium like with decreasing returns (classical economics). Several contenders compete and the market picks the winner at random. What is more reliable is path dependence, a.k.a. first mover advantage. So, yes, it’s complicated.

This is what Google thinks about it today, search “project management software” and this is what you get, TEAM, MSFT, TEAM, SMAR, others.

http://softwaretimes.com/pics/smar-pms.png

https://www.google.com/search?client=safari&rls=en&q…

I know nothing about Microsoft Project. Jira and Basecamp are tools for developers and not real competitors with SmartSheets. I interpret the Google result as SmartSheets being third in line but with a caveat, Trello and Microsoft Project could be getting their shine from their parent organizations.

In this case I’m following Geoffrey Moore’s Gorilla Game advice, “Buy the basket and sell the losers.” I’m long SMAR and TEAM.

Elsewhere I posted my IT based opinion of SmartSheets which could well have the same IT blinders I mentioned above. :wink:

Denny Schlesinger

Basecamp history: https://medium.com/@jasonfried/basecamp-the-origin-story-f50…

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SMAR has an impressive customer list. Paypal, Netflix, Cisco,etc.

And does the competition also have built in connectors to SalesForce, Microsoft Office365, Google Apps, Box, Dropbox, Skype, etc.?

Perhaps they have an exceptional product worth spending the sales and marketing dollars on?

I truly don’t know the answers to these questions.

Peace,
Dana

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Saul,

I truly respect your track record and admire your investing skills so please don’t take this post as a criticism; am merely sharing my thoughts with you…

As far as I can tell, for over 25+ years of investing, you strictly followed the GARP strategy (Growth at a reasonable price or PEG ratio of 1 or thereabouts) and this approach helped you amass an incredible long-term track record! So, for more than 25 years and up until two years ago, ‘valuation’ seemed to be at the heart of your investment process (and success).

In early 2017, you (to your credit) caught on to the Saas/cloud secular trend and went ‘all in’.

If you review your entries in these companies, you’ll realise that you invested in them when their valuations were low (i.e. TWLO was trading at 7 times sales, SHOP and SQ were much cheaper too). So, the vast majority of your returns over the past two years have come from multiple expansion (TWLO is now trading above 20 times sales versus around 7 just two years ago i.e. 3X return from multiple expansion).

Currently, you state that valuation doesn’t matter but isn’t ‘investing at a cheap/fair valuation’ the reason why you’ve been so successful as an investor?

If multiple expansion of these Saas stocks was the main driver of the stock price appreciation over the past two years, then do you believe that these valuations will stretch even further and one day TWLO ZS OKTA MDB will trade at 30 or 40 times revenue?

Again, I’m not criticising or attacking you - am simply making an observation.

Best,

GM

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I’d like to find another company that would be in the top category and I high confidence company? Any suggestions?

Sometimes the hardest thing to do, is to do nothing.

I don’t think you’re question was - “show me a new company” - it was - “convince me that I shouldn’t give up on these companies and put my money into these other 6”

I could not argue the decision to exit the companies and move your money into the other 6. You have the advantage as an agile investor to jump in and out. The only limitation there is how much risk you are willing to digest and concentrate. Personally, it’s a little much for me, but to each woman/man their own.

Personally, I think the only company not on your list that is building its own category and growing at a rapid pace (>50%) is SHOP. You have your own intuitions on SHOP. But it is founder led, it is highly innovative, it makes the ability to build a web-based business seamless, and it continues to push to envelope in that space. All characteristics that I want in a high conviction stock.

My only observation is this: you are using ~15% of your portfolio to cast a few lines searching for the next big fish. You are seeking “coiled springs” or “emerging opportunities” that can grow over the next couple of years. That is what I would categorize every suggestion

Time and performance will provide the only proof to build confidence. What I noticed about your question companies are that they are all relatively new to your portfolio. You haven’t had the “soak” time to learn about the companies and track them closely as you do.

DarthTaco mentioned EVBG as a company without competition (true) that is founder led (although he is retiring this year) and is accelerating growth into new markets and expanding growth through new offerings. I would consider EVBG as something you could “test” with a deep dive.

While all the companies you mentioned are performing well, none of them are at a “breakout” point. None of them are without competition. None of them are without question.

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If you review your entries in these companies, you’ll realise that you invested in them when their valuations were low (i.e. TWLO was trading at 7 times sales, SHOP and SQ were much cheaper too). So, the vast majority of your returns over the past two years have come from multiple expansion (TWLO is now trading above 20 times sales versus around 7 just two years ago i.e. 3X return from multiple expansion).

Currently, you state that valuation doesn’t matter but isn’t ‘investing at a cheap/fair valuation’ the reason why you’ve been so successful as an investor?

If multiple expansion of these Saas stocks was the main driver of the stock price appreciation over the past two years, then do you believe that these valuations will stretch even further and one day TWLO ZS OKTA MDB will trade at 30 or 40 times revenue?

Yes, I think that valuation does matter. If a company is growing revenue at 60% then it’s EV/sales ratio drops very quickly as time passes. Let’s take TWLO as an example. It currently has a EV/sales ratio (based on TTM revenue) of 20.1 ($13.1B / $650M). It’s growth rate in the past year was 63%. Assuming that growth continues at the same rate then it will have a EV/sales ratio of 12.3 in about 11 months and and a ratio of 7.6 in 23 months. The risk of course is if the growth rate slows. But in the absence of slowing growth the growth rate is a good protector against multiple compression.

Now if we look at a company with a EV/sales multiple of 13 that is growing at 30% then in a year the ratio drops to 10 and in 2 years the ratio drops to 7.7.

So looking 2 years out the companies end up in the same spot assuming that the stock price and the respective growth rates remain constant.

Thus, the companies that have a higher growth rate have a higher valuation for good reason. The trick is to quickly identify (and act on it) if growth slows. Saul is ruthless with this. An example is selling out of SHOP when the rate of growth slowed. SHOP’s stock price has not dropped and its growth is still above 50%. I guess we will see if SHOP’s growth reaccelerates and what happens to the stock price.

Chris

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Chris,

The valuations of a few companies are provided below -

Company

Saul

You have had some very detailed responses, so I’ll just try to go of the gaps from my point of view.

No issues with your top 6, although I am more cautious about OKTA and ESTC…but maybe that is why my results lag yours.

GH: I had over 10 years experience in life sciences earlier in my career and have a pretty good understanding of the underlying forces, which are highly stochastic in nature. I would either be investing in several, playing a binary event strategy with options rather than stock, or running an income strategy - non of which are in your playbook.

DOCU: Don’t hold it but am interested, driven by its success in the market place (becoming a verb etc).

COUPA: Don’t hold it and probably won’t. I despise the space from a product point-of-view, speaking as a vendor who has to deal with large companies who use platforms such as Ariba and Hiperos. From an investment point of view my concern would be that the TAM is pretty much defined now by Ariba/SAP.

ZUO: Don’t hold and probably won’t. There are plenty of pricing companies out there. I remember reading early on that ZUO’s USP was the way that it made accounting under ASC 606 more straightforward…which gives it a target market for its USP of all US public companies with significant subscription business. A decent sized market to be sure, but not huge. I also read that their business model included being paid a % of each transaction…just not going to happen. Any company needs to understand where it comes in the pecking order of services for its customers: a vendor that is contributing to the end product may be able to justify a % of the selling price, but no sensible company is going to give that just for keeping the books.

What I do hold instead (I like to find Financials + Product + Management, most of my comments will center on Product as you have the others pretty well covered):

PAYC: This was a rec from MF Pro and has performed very well for me. One key driver that Pro noticed which I have not seen mentioned anywhere else is geography: the company is systematically opening up sales offices in a few new states each year. This gives them a significant chunk of new business to attack each year, while they grow what they already had.

TEAM. Lots written on this, but Jira is to developers a bit like quickbooks is to small company bookkeepers…when they go to a new company that doesn’t have a ‘system’ they will champion what they know because they know it works, and all of the new team become proseletized for when they move on. And there is a lot of career movement with software developers. (And Jira is a great product whereas Quickbooks is Quickbooks).

MDB: lots written. Evolving standard.

ZEN: Fantastic product, revolutionizes a company’s approach to customer support & works out of the box. Have held it since 2015.

ANET: I like the ‘hardware’ diversification this gives me and has products that I can roughly understand. Stellar management. (So at least 2 things that I now realize NTNX does not have)

CLDR: This one is down to Bert: he seems to really believe in the potential acquisition synergies and thinks that the market are ignoring them. The 2 companies were probably young enough that he may be right. They report later this week, so you might want to prioritize this for a research look.

I hope this is useful - I don’t tend to contribute much on this board, so it felt appropriate to do so here.

Cheers

Cham

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Chris,

The historic and current valuations (P/S) of a few companies are provided below -

Company 2017 Current

Alteryx 12 18
Okta 11 21
MongoDB 10 24
ZScaler N.A. 30
Twilio 6 23

Company 2016 Current

TradeDesk 6 19

Company 2015 Current

Shopify 11 19
Square 3 9

The above data makes it very clear that most of the returns from the Saas stocks over the past few years have come from multiple/valuation expansion (not from the growth of the underlying business).

An investor’s return is dependent upon two things - growth of business and valuation expansion.

For 2-3 years, investors in Saas companies have benefited from both (business growth + incredible valuation expansion!)

Now that valuations are already stretched, one tailwind has disappeared and investors are now solely dependent on the future growth of the underlying business. Given these valuations; the market has already priced in ‘perfection’ and any whiff of disappointment will crater these stocks (i.e. Nutanix).

For some reference, the market darlings of the TMT bubble (Cisco and Microsoft) both peaked around 25 times revenue and in the crash, MSFT declined 66% and CSCO tanked 90%. By the way, during that bear-market, their businesses continued to grow at a healthy clip but the stocks didn’t hold up.

Best,

GM

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Now that valuations are already stretched

Fact: valuations are higher. Your opinion: they are stretched.

investors are now solely dependent on the future growth of the underlying business

If ratios remain constant and growth continues at the same rate then you can still get great returns.

Given these valuations; the market has already priced in ‘perfection’

This is an opinion. Clearly, many disagree or the prices would be lower.

any whiff of disappointment will crater these stocks (i.e. Nutanix)

I would call NTNX’s trouble more than a mere whiff of disappointment. No one can know how the price will react to disappointment and no one can know the degree to which a stock might drop.

Many of the companies discussed here are showing no signs of slowing growth. In fact, some of them are showing accelerating growth while the others are stable.

GM, You seem to think that you know what EV/sales ratio is “fair value”. What is that number? How much more should a company be worth that’s growing 60% compares to one that’s growing only 30%? It’s highly probable that these companies will run into some speed bumps. There may be execution speed bumps and there many be market selloffs. But so long as the business results keep delivering these companies will get a lot bigger. Most are still under $10B market cap companies and I think some will grow to $50B or even much bigger.

When CSCO and MSFT reached their highs in the late 90s, they were profitable businesses with earnings. I think their P/Es were something like 80 or 100. Clearly this was a bubble and those were crazy times. Comparing that time to the current time is not a fair comparison.

Chris

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Saul:

Here is my deep dive on Invitae:

https://discussion.fool.com/deep-dive-invitae-34140364.aspx?sort…

It’s important to know that my position taken on 2/11 is up 46%. That’s a steep rise over a very short period.

I own a 2% position in ZUO. I posted a deep dive on this board. I don’t plan to add to it. Their stated goal for growth is 25%. They will grow as the subscription economy grows. Their costs of services needs to come down a lot before I buy more. I may sell out after a couple more quarters if this metric does not improve. (I am ZUO ticker guide). Here is my Deep Dive on ZUO:

https://discussion.fool.com/another-look-at-zuo-34110062.aspx

I own a 4% position in DOCU. I like this company a lot. But it will probably not grow at the rate of your top 6 in the near term. I don’t plan to add to this position much, until they prove out their concept: System of Agreement. I view this as an anchor position. Here is my Deep Dive on DOCU (I am ticker guide):

https://discussion.fool.com/docu-deep-dive-34121285.aspx

Best, Swift…
Long NVTA, ZUO, DOCU

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