Informative Back Test

I figured there would be a response like this, but I still believe what I said. I’m not talking generic label food manufacturer recession proof, but in general, these SaaS companies are SAVING the company money. That is the whole point of many of their existence.

They are not making equipment used in manufacturing (where orders can dry up).

They are not making luxury items.

They are not making building materials (where building can go down in a recession). They don’t depend on new builds whatsoever.

They are not in the advertising industry (aside from TTD), meaning they are not subject to ad spend cuts common in recessions. They don’t depend on advertising dollars like internet boom 1.0.

I know people are going to disagree and say that’s reckless behavior (I don’t care, I don’t do macroeconomics anyways so not plotting for a recession or making it a factor in my decisions, I’m only trying to rationalize the resilience they show during market drops). But those people who disagree should at least admit this group of growth companies are doing something materially different than many previous growth industries-saving companies money.

I also don’t care about subscriptions or “not having to start each year with $0 revenue.” Subscriptions can be cancelled and not renewed, there’s such a thing as backlog that carries over to each new fiscal year for virtually every b2b company. Texas Instruments has design wins that will see repeat orders year after year. Xilinx has design wins that will see repeat orders for sockets that can only use their chips. But they are making “stuff” which is generally an extra expense. But you tell me if you need to cut back on security spend how you get rid of ZScaler when the whole reason you bought it is because it saves you money.

4 Likes

Thanks Saul.

As a longtime denizen, I find your monthly summaries sufficient as illustrations of this principle. Perhaps I should have qualified my opinion - I’m not without gratitude for you and the other prolific posters on this board.

I recognize the risks inherent in my stock selections. Doesn’t stop me from being long companies such as SHOP, TTD, ZS, OKTA and SMAR, nor does it keep me from being essentially fully invested. My portfolio is not nearly as concentrated as some here (and my results would clearly reflect that) but we all walk our own path.

Keep up the good work.

2 Likes

I figured there would be a response like this, but I still believe what I said. I’m not talking generic label food manufacturer recession proof, but in general, these SaaS companies are SAVING the company money. That is the whole point of many of their existence…But you tell me if you need to cut back on security spend how you get rid of ZScaler when the whole reason you bought it is because it saves you money.

Hi 12x,

You may be correct that current customers will not get rid of these SaaS companies during a recession, but it seems the risk would be potential customers delaying their spending for a new SaaS purchase and also current customers not expanding their spending? Using your example of ZScaler, a company may not go away from using Zscaler during a recession, but a company using a competing security product that was considering switching may just decide to wait until their business gets better.

If one of these companies goes from 60% growth down to 10 or 20% growth they are going to get hit hard also I would think.

Of course, I have no idea what will actually happen.

Brian

1 Like

For another example of how our overpriced SaaS stocks get killed when the market is retracting, I noticed just now that the market was having a bad day. The Dow, S&P, Russell, Nasdaq, and IJS, which are the five indexes that I follow, were down an average of 0.75% a little while ago. That’s a bunch. And my portfolio was only down 0.60%… Oh, excuse me, my portfolio was up, not down, 0.60% ! Shows once again how vulnerable we are! Yep!

I have been talking about this excessively, partly because there has been so much talk on the board about how dangerous our stocks are in a downturn. I will work on holding myself back.

Sorry, but I failed. I can’t control myself. Last post on this for the time being. I promise. Look, it’s almost been treated as a given by some people that when the market falls our excessively overvalued stocks will just get killed. And those people maintain that position in spite of the fact that that hasn’t happened in any of the recent major substantial declines. Well right now today is another mini-example. I have tried over and over again to explain that our SaaS stocks may not be overvalued after all, so I’m not going to go through it again. But here are today’s results. Those five indexes finished down :

0.43%
0.48%
0.78%
0.90%
and
0.95%

The average of the five finished down 0.71, which is a a reasonably substantial one-day fall, and a fall which was consistent among all the averages from small value stocks, through Nasdeq tech stocks, and on to the behemoths of the S&P and the Dow.

My portfolio made up of overvalued but innovative, secure, and dominant companies with high growth, high gross margins, and almost all recurring revenue, was up 1.20% !!!

There it is !!! I’m finished. I absolutely promise you won’t hear another word from me on this this month, and maybe even longer. And remember, I may be wrong totally.

Sual

36 Likes

I don’t report on my portfolio but


AYX  + $0.78 0.67%
TEAM + $2.82 2.09%
ZS   + $0.73 0.88% 

made new all time highs today.

Denny Schlesinger

2 Likes

I figured there would be a response like this, but I still believe what I said. I’m not talking generic label food manufacturer recession proof, but in general, these SaaS companies are SAVING the company money. That is the whole point of many of their existence…But you tell me if you need to cut back on security spend how you get rid of ZScaler when the whole reason you bought it is because it saves you money.

It is not likely that companies cut back on keeping proper security, what is likely if you have a recession is that some companies go away and many cut back. When those companies cut employees and look around at other expenses, they may find that have for too many licenses for Office365, SFDC, ServiceMax, ZS, OKTA, TEAM, etc. They likely may or may not be able to do something at the time though likely will try to cut back those expenses. Certainly, when renewal time comes, they will not be happy paying for unused seats, they will want to cut back and may check where they can do without.

Other companies will not move forward with new initiatives during those times even if you can show a positive ROI. There are so many investment dollars companies make and they usually plan them in advance for projects needed over the next 1-3 or 1-5 years. A lot of the projects that seem a nice to have go to a waiting pattern. IT may argue ZS will save money and should get the investment dollars, the Sales VP may argue for a different project will help generate more revenue by providing better insights to the sales team.

Nothing is immune to a slow down though certainly the SAAS have a strong foothold once inside.

4 Likes

I manage budget for a large corporation. We still have 80% of IT budget in non-Saas legacy systems. I certainly want to cut expense during recession, but I will cut those first before touching critical Saas applications.

20 Likes

And, we need to be clear that SaaS is just a licensing model … while it is often associated with mission critical functions where it is unlikely to be abandoned, the same model can be used with less mission critical functions where substitutions and such may provide alternatives. E.g., we have reports that Zoom provides a superior functionality at present that is driving extremely rapid growth. But it is also clear that there are other solutions often in use in parallel, if only to accommodate those on the other end of the line. In a serious enough recessions, price might become an important determinant in what solution was used, even if it was not quite the best.

2 Likes

tamhas is right… you would see companies motivated to cut their opex to the bone in recession… heck, they even start doing that in fear of recession…

May be a better exercise for us to do us reason out which companies will operate well in a tougher environment and which one may have challenges…

I see our companies in two buckets…
Bucket One that will thrive in tougher environment because not only they offer SAAS, they also reduce cost right away… take for example AYX… they save so much time and in turn cost that they would have even stronger value proposition for companies to adapt in cost cutting environment… AYX is not so much SAAS as we have discussed on this board at-length… another example would be ZS… their entire value prop is reducing your security and network infrastructure cost to even less than half (or far less than half) of what you may be incurring today… and I can see similar examples where companies would move away from legacy on-prem software to SAAS software faster in a recession because that can reduce cash outlay (why spend on large, one time, on-prem 3 yrs or 5 yrs license when you can pay monthly)…
(I think MDB belongs to this category theoretically, but I am not sure people would really replace legacy database with MDB… So I am not counting on it)

May be others can chime in and qualify more companies in this bucket.

The second bucket is where there is some risk. These companies have leveraged themselves to their customer spend… e.g. communication companies like ZM, TWLO… the more customers use, the more they pay… and for sure, customers will continue use them, just the level of usage will go down in a recession… due to fewer employees, fewer customers etc… I believe OKTA, SMAR, SQ, SHOP, COUP will fall into this category… for sure these companies will do better than average tech company and much better than most legacy companies but they likely to perform poor compared to the first bucket…

at-least thats what I think…

Now here is the twist… companies in second bucket do much much better in growing economy even compared to first bucket… so I wouldn’t abandon these companies BEFORE recession is evident… you dont want to miss these tremendous leverages upside “in the hope of recession” (yes, I am being sarcastic to those we have been waiting for recession since 2012)

The one thing I do worry about right now… is the impact of tariff on our companies… again, i think we haven’t seen impact yet but if it shows up, I would worry about companies serving economically lower strata of population… to me SQ falls into this very strongly… HUBS to a large extent and so does SHOP… while I have been big proponent of SQ and continue to hold, this one is the only concern I have today from macro perspective. And as you can tell, I am not “hoping for recession”…

comments??

3 Likes

The second bucket is where there is some risk. These companies have leveraged themselves to their customer spend… e.g. communication companies like ZM, TWLO… the more customers use, the more they pay… and for sure, customers will continue use them, just the level of usage will go down in a recession… due to fewer employees, fewer customers etc… I believe OKTA, SMAR, SQ, SHOP, COUP will fall into this category… for sure these companies will do better than average tech company and much better than most legacy companies but they likely to perform poor compared to the first bucket…

I am not sure why ZS wouldn’t fall into this bucket then I am not sure I understand their model well enough. But wouldn’t the number of use cases they have depend on the number of employees and applications that can use their solution? Isn’t the largest use of their product to help support Office 365 secure connections for companies? A few things will happen in a recession, 1. companies not decided will likely freeze their decision to spend for growth would slow. 2. Companies that reduce employees will by paying for too many seats or be over subscribed. They will try to reduce and cut those expenses. Maybe before the contract ends but certainly will not renew for what the previously used.

I may be misunderstanding their model things will certainly change. They may not suffer negative growth like hardware companies often do, but they will struggle not only to increase new sales but will also fight to keep existing customers that the previous levels they were at. I’ve seen many companies be a bit too liberal in granting rights to many applications when they are not too worried about expenses to only start questioning and removing licenses to large groups of users that hold licenses or subscriptions just due to them being nice to have vs needed to perform your job

Hi jdc…

i think you are right in terms of ZS usage going down in terms of # of employees… etc… however, I am not sure if their pricing is on # of employees… for that matter, i do not know their pricing model…

where I see they benefit is getting more new clients… if they can reduce client’s annual cost down to 25% or lower as they claim, in a recession where cost saving becomes paramount, clients would be motivated to overcome internal resistance (entrenched infrastructure… may be IT folk’s resistance) to reduce cost right away… so I think ZS would benefit in a recession… transition to cloud should accelerate in general and specifically for ZS as cost reduction is very high…

1 Like

so I think ZS would benefit in a recession…

While it sounds logical for companies to promote this and would likely be part of the sales teams playbook when they help show potential customers the ROI they would get by spending money with them, I just seldom see it actually work in practice. Companies shut down spending, even if the ROI looks good on paper. They just don’t spend and still find ways to get by with what they have.

Video conference companies have always look like a good alternative (and likely use it during their sales pitch) to help companies cut travel costs when budgets get tight and a recession happens. The reality is, companies stop traveling as well as don’t pay for alternatives like video. I just don’t think most companies ever benefit from a recession if their model is to help companies operate more efficiently in the good times. Some companies do well during a recession but their model is dependent on it.

2 Likes